Bank of America TARP Repayment Premature, Analyst Says

A leading bank analyst says the regulators who allowed Bank of America to repay its $45 billion in government bailout funds made a big mistake because the bank may well need that money soon to withstand the next wave of bad loans, the withdrawal of federal subsidies, and the possible reevaluation of assets.

Wall Street celebrated the bank's liberation from onerous conditions that accompanied the bailout funds; government officials crowed that taxpayers made a profit on the deal; the media marveled at the banking sector's swift recovery.

But Christopher Whalen, a bank analyst at Institutional Risk Analytics, says Bank of America's loans continue to sour. Defaults more than tripled from the first quarter to the third; loans more than 90 days delinquent and those so late they're no longer accruing interest have shot up 15 percent, according to an analysis of banking data.

That's because, despite signs of recovery at the macro level, it takes time for homeowners to become delinquent on their mortgages and credit cards after a job loss.

To pay taxpayers back, the firm says it will use about $26 billion in excess cash "at precisely the time when the [Federal Reserve] is withdrawing many forms of subsidies for the largest banks", notes Whalen's IRA Advisory Service report. That cash could be used to guard against future losses.

"If you want a very tangible example of why the Fed should be taken out of the business of bank supervision, it is precisely the TARP repayment by [Bank of America]," Whalen writes. The Fed supervises Bank of America because it is a bank-holding company. While other regulators supervise units of the firm, the Fed is responsible for the entire corporation. The bank can't repay taxpayers without the Fed's permission.

Whalen argues that bank regulators should force the firm to raise capital now and keep it until the middle of next year when Bank of America's losses are more clear.

"Apparently allowing outgoing CEO Ken Lewis to take a victory lap via TARP repayment is more important to the Fed than ensuring the safety and soundness of [Bank of America]," Whalen writes.

Reached late Friday, a company spokesman said the firm typically doesn't comment on analyst reports.

Whalen notes that large banks may experience higher losses next year from sour loans. In a research note this week, analysts at Goldman Sachs said they expect the unemployment rate to hit 10.75 percent by early 2011, a 0.75 percent increase from the current rate.

It's not just worsening loans, though, that has Whalen concerned. He also points to optimistic real estate valuations on Wall Street, noting that prices have been "greatly helped" by the Federal Reserve. The Fed has purchased some $850 billion worth of mortgage-backed securities since last year.

"Simply put, the Fed has forcibly revalued toxic waste" through its purchases, Whalen said. The true value of the loans on the bank's books are in question.

The Fed is "betting on concluding the bank rescue...in the next year or so," he writes. But the assumption "may not be fully supported by reality on the ground."