Did B of A Set Itself Up for a Fed Veto on Capital Plan?

It took only a fortnight for confidence to become hubris.

Bank of America Corp.'s assurance to investors two weeks ago that it would return more capital to them in the year's second half has come back to bite the bank, and may have even hurt its chances of increasing the quarterly dividend payout.

It is difficult to pinpoint why regulators didn't approve the capital plan Bank of America submitted along with the other 18 largest U.S. banks earlier this year, since neither the bank nor the Federal Reserve Board, which conducted the test, is providing those details. But the Fed clearly thought B of A's request was too much, too soon, experts said.

"We don't really know the underlying cause, but clearly, whatever Bank of America put out there would appear to have been too aggressive a plan relative to what the Federal Reserve wanted," said Frederick Cannon, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc.

B of A no doubt has its share of problems to deal with, including a large portfolio of underperforming mortgages it inherited from Countrywide Financial Corp., so for some, its revelation on Wednesday that the Fed denied its request to raise its penny-a-share dividend in the second half of this year was not shocking.

Still, some were left wondering why the bank was seemingly left out of the dividend game, considering that the other top three banks, JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co., have all received approval to distribute more capital back to shareholders.

"They said, 'no' on Bank of America so they can be shown to be tough with respect to one institution," said Chris Whalen, of Institutional Risk Analytics, referring to regulators. "So it looks like Bank of America turns out to be the whipping boy."

Josh Rosner, managing director of Graham Fisher & Co., said flawed tactics may be behind B of A's rejection. In the months preceding the capital adequacy test, B of A's chief executive Brian Moynihan offered analysts a show of confidence in the company's readiness to pay out capital.

When asked at a financial services conference in December whether a 2011 dividend was likely, he said he didn't see anything that would stand in the bank's way.

"We are going to do it as fast as we can," he added.

And earlier this month, at the bank's first investor day conference in four years, much of the rhetoric from Moynihan and his team centered on how the bank would return significant capital to shareholders over time.

Comments like that may have pushed the Fed into a corner, Rosner said.

"For Bank of America to have taken that tack ahead of the stress test being done was to say that either the Fed was in their pocket or they were going to force the Fed's hand if they weren't," he said. "And the Fed had to respond in a manner that maintained its credibility."

Rosner also suggested that B of A's rejection may have been the flipside of the Fed's reluctance to become the arbiter of specific institutions' dividend payout ratios. While there is no way to say what Bank of America asked for, the Fed regularly said that approval of the capital plans was simply an all-or-nothing proposition.

"You don't want to tell management specifically what to do, and you don't want to get into an iterative process," Rosner said of the regulator's approach. "Had [B of A] gone in and asked for something really small, it might have been a different result."

B of A has paid a penny-a-share dividend for nine straight quarters; It first slashed its dividend to 1 cent — from 32 cents — in the first quarter of 2009. That was after the bank had already cut its dividend in half, from a high of 64 cents, in late 2008.

B of A's confidence over the past few months has been in stark contrast to the more tempered tone at Citigroup, which had been saying for weeks that it did not plan to return capital to shareholders until some time in 2012.

That has accounted for the surprise when Citi announced on Monday that it was reinstating its dividend and undergoing a 1-for-10 reverse stock split that would take the share price back up to the mid-$40 range.

But analysts said one must keep Citi's 1-cent dividend in perspective.

"Citi got their capital plan approved, but the amount of capital distribution is very small," Cannon said. "It could simply be that Bank of America's capital distribution request was more than $29 million a quarter," he added, referring to the payout Citi will make once the stock split is conducted.

Others thought that B of A may have just made the request too far in advance. Many of the 19 banks undergoing the stress test were seeking to raise their dividend in the second quarter, while B of A asked for a dividend hike in the second half of this year.

"Given there's still a lot of uncertainty out there, I think they were probably conservative — the Fed, that is — and chose to have them resubmit with more updated, recent data points," Marquardt said.

"Again, it does highlight the fact that the management of this whole issue was poorly [handled] by Bank of America," he added. "They were just at their investor day talking about having a modest dividend increase in the second half of the year. … I think what's surprising is that it almost feels like they were not on the same page as the Fed. And there might have been a difference between their view and the Fed's view."

In the end, the fact that B of A's request was denied is a reminder to some of just how far the financial system has come since the first round of stress tests two years ago.

"To some degree, the fact that the Fed can object to a large bank's capital plan is a sign the system is in a better place," Cannon said. "They don't have to fear that there would be some type of liquidity event at the company. … I don't think anybody would say Bank of America is financially threatened. They just couldn't get the dividend through the Fed."

In 2009, "we were talking about how much capital each bank needed to raise. Now we're talking about how much capital each bank can distribute," he added. "That's a fundamentally different position."

Not every bank that went through the stress test has announced results publicly. Ally Financial Inc., American Express Co., Morgan Stanley and MetLife Inc. have all been mum.

B of A spokesman Jerry Dubrowski said the bank "felt it was important to disclose the decision the Fed made and to make sure that all of our shareholders were aware of it."

In the end, investors took the news in stride. After being down as much as 3.7% earlier in the day, B of A shares closed Wednesday down just 1.6%, or 23 cents, to $13.65.

B of A also assured investors it is not giving up. The bank said it plans to resubmit a request for a second-half dividend hike this summer.