Updated with market close information.
NEW YORK (
) -- With year-end predictions providing so much
, here's a chaotic possibility to consider:
What would happen if
Bank of America
were to suffer a run on deposits?
"Cash or bullion?"
While most of the discussion on regulatory reform in the wake of the banking crisis of 2008 has focused on capital strength, lending standards and mortgage loan servicing, it's liquidity problems that can quickly kill a bank.
We saw that with
, which relied on short-term funding before it went bankrupt in September 2008, with
feeding off the carcass.
Amid its own liquidity crisis, the well-capitalized
had avoided bankruptcy in March 2008, when the
facilitated a quick sale of the firm to
Liquidity concerns were also at the forefront of the decision by the Office of Thrift Supervision -- with prodding form the Federal Deposit Insurance Corp. -- to shutter Washington Mutual in September 2008, which was sold by the FDIC to JPMorgan Chase. During the final weeks before it became the largest bank or thrift to fail in U.S. history, Washington Mutual was offering rates for six-month CDs that were twice the national average.
A relatively limited run on deposits in August 2007 and other liquidity concerns also factored into Countrywide Financial's decision to bail in January 2008, when it announced a deal for
Bank of America
to buy the company. Other thrifts seeing runs on deposits before failure included IndyMac Bank, which failed in July 2008, and Downey Savings & Loan, which was shut down by the OTS in November 2008.
While most of the coverage of the regulatory changes spurred by the Dodd Frank Wall Street Reform and Consumer Protection Act -- signed into law by President Obama in July of last year -- have focused on threats to large banks' revenue from lower debit card interchange fees as required by the Durbin Amendment, and from the ban on "proprietary trading" required by the
, along with enhanced capital requirements and Federal Reserve
, Dodd-Frank also addressed liquidity.
to enhance oversight of large financial holding companies last week, the Federal Reserve confirmed its plans to adopt the Basel III framework for enhanced capital requirements, and also said it would follow the Basel Committee's lead in gauging holding companies' liquidity, through two liquidity ratios. The liquidity coverage ratio (LCR) is "designed to promote the short-term resiliency of a banking organization's liquidity risk profile by ensuring that it has sufficient high quality liquid resources to survive an acute stress scenario lasting for one month," and the net stable funding ratio (NSFR), "is designed to promote liquidity risk resilience over a longer time period and to create incentives for a banking organization to fund its activities with medium- and longer-term funding sources."
So where does this leave Bank of America?
While it was the second largest U.S. bank holding company by total assets as of Sept. 30 -- trailing JPMorgan Chase -- Bank of America still had the first-place domestic deposit market share, with $953 billion in U.S. deposits, according to Federal Reserve data provided by SNL Financial.
Bank of America's total deposits increased 5% year-over-year, while the company's total assets declined by 5% to $2.2 trillion as of Sept. 30. The company's ratio of loans to deposits declined to 94% from 100% a year earlier, while its liquidity ratio -- defined by SNL as cash, securities, federal funds sold, securities purchased under agreements to resell, and trading assets, divided by total liabilities -- was 43.77% as of Sept. 30, declining slightly from 45.26% a year earlier.
Looking beyond these surface numbers, Guggenheim Securities analyst Marty Mosby said in a report last week that the largest U.S. banks had seen a "dramatic improvement in liquidity" over the past three years, "improving from a shortage of $139 billion in 2007 to an excess of $320 billion in 2011."
According to Mosby, the banks continue to build liquidity as they await "catalysts" to deploy funds, including a recovery in loan demand and securities rates climbing above 4%.
But what about a liquidity crisis springing from a split of the euro or some other cataclysmic event? While euro-zone pressure has subsided over the past two weeks, we could see more turmoil in 2012, if the continent continues its slide toward recession.
Mosby called "a retail run on a bank is the worst-case scenario for most," and said that "If a bank could survive this scenario then the regulators would feel comfortable that liquidity should not be an issue for this bank, if ever that event should arise."
Guggenheim estimates that Basel guidelines on liquidity measurements "were developed with a European bias," since they don't take give U.S. banks "credit for being able to borrow funds from the Federal Home Loan Banks, FHLBs, and the total run-off of retail deposits is assumed to be much higher since the European banks don't have the benefit of FDIC insurance."
In its Liquidity Crisis Coverage Test, Guggenheim used "the historical deposit run-off of U.S. banks that eventually failed," with its analysis showing "that about 20% of retail deposits will run-off in that scenario as depositors become worried that access to their accounts may become limited." The Basel guidelines assume a 30% deposit run-off.
Of course, as we have seen in the latter part of the banking crisis, nearly all depositors of failed banks have been made whole, even if their balances greatly exceeded the FDIC's basic deposit insurance coverage limit of $250,000.
According to Mosby, there are three stages of a liquidity crisis for a bank. First, "wholesale funding sources don't renew," after which "institutional funds begin to be drawn down," and "lastly, retail depositors withdraw balances."
Of course, for Lehman brothers and now
, the lack of support from a retail deposit base meant that a souring of confidence among other institutions resulted in an almost instant liquidity shortage.
Mosby estimates that Bank of America has sufficient liquidity for coverage in all three stages of a liquidity crisis.
If 100% of the company's borrowings with maturities of one year or less were to run-off, available cash and equivalents, securities available for sale (net of marks-to-market) and the company's "capacity to withdraw collateralized funds from Fed and FHLB," would leave Bank of America with $32.2 billion in excess liquidity.
If 50% of Bank of America's institutional deposits and jumbo CDs were drawn down, funding of trading assets and loans held-for-sale through the repo market and the collateralization or sale of one-to-four family mortgage loans, would leave the company with $353 billion in excess liquidity.
In the "third stage" of a liquidity crisis, with Bank of America seeing the remaining 50% of institutional deposits and Jumbo CDs taking flight, Mosby said that "incremental available funds to replace run-off," including proceeds from the sale of held-to-maturity securities, the sale or securitization of home equity and credit card loans, and the draw-down of "10% of unused loan commitments," would leave the company with $205.7 billion in excess liquidity.
Of course, the company's ability to complete all of the required actions to shore up its liquidity amidst an earth-shattering crisis could be questioned, since a lock-up of funding sources for the second-largest U.S. bank would probably mean that potential buyers of bulk assets would have their own liquidity problems, but Mosby's figures provide a great deal of comfort.
Bank of America CEO Brian Moynihan said on Friday in a year-end letter to employees that the company had continued to "simplify" during 2011 and was "exposed to less risk."
The shares rose over 3% on Thursday, to close at $5.46.
Interested in more on Bank of America? See TheStreet Ratings' report card for
Written by Philip van Doorn in Jupiter, Fla.
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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.