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FDIC's Bank of America Lawsuit Is Really Just a 'Contract Dispute'

James Langford

The following article, originally published at 7:01 p.m. on Monday, Jan. 9, 2017, has been updated with analyst commentary and market reaction.

The Federal Deposit Insurance Corp.'s lawsuit seeking $542 million in underpaid insurance premiums from Bank of America  amounts to a 'contract dispute' that can be settled without hurting the lender's long-term performance, an analyst says.

The Charlotte, N.C.-based company's fees "have reflected the higher expense," so the operating earnings outlook shouldn't be hurt though the bank will have to pay some amount to the FDIC, Brian Kleinhanzl of brokerage Keefe, Bruyette & Woods said in a note to clients. 

The agency's lawsuit, filed Monday in federal court in Washington, attributes the underpaid premiums to a discrepancy in key risk reports from the company, the second-largest U.S. bank by deposits.

Created in 1933 to protect consumers from bank failures like those during the Great Depression, the FDIC insures bank deposits up to $250,000, guaranteeing customers have access to their money when a financial institution collapses. Its insurance fund, buoyed in the wake of the 2008 financial crisis, is financed through quarterly risk-based premiums from covered banks, with large complex companies paying the highest charges.

The assessment for those firms, which include the likes of JPMorgan Chase and Citigroup as well as Bank of America, is based on self-reported data that includes money owed by other companies, known as counterparties, according to the suit. The system assumes that the more concentrated a bank's exposure is to a particular counterparty, the higher is its degree of risk.

As a result, lenders are required to report payments owed by parent companies as a whole rather than their individual operating units or subsidiaries. Because Bank of America didn't comply with that rule, it under-reported its exposures "by tens of billions of dollars" from the second quarter of 2011 through the first quarter of 2016, according to the suit, filed in federal district court in Washington.

Bank of America held about $1.2 trillion in deposits as of Sept. 30, some $700 billion of which was insured by the FDIC, according to the lawsuit. The amount sought in the case is for premiums from the second quarter of 2013 through the end of 2014, but the FDIC reserved the right to change the total after determining what the bank should have paid before that time.

The dispute arises "from a technical disagreement about a calculation from several years ago regarding a rule that has had changing provisions over time" said Lawrence Grayson, a Bank of America spokesman who noted that the $542 million comprises only a fraction of what the company pays to the FDIC each year.

"We have kept the FDIC regularly updated on our calculations," he added. "We look forward to the court's review."

While the requirement changed significantly in 2014, the FDIC's suit claims that what the agency "added in 2014 is actually what the rule said all along," said Eugene Scalia, a partner in the Washington office of Gibson, Dunn & Crutcher who's representing the bank.

"Our position is that the new words gave the regulation new meaning," said Scalia, the son of late U.S. Supreme Court Justice Antonin Scalia. "That new meaning can't be applied retroactively, especially because the FDIC never gave Bank of America fair notice of its view prior to this year. The FDIC also will have difficulty explaining how it could have been unaware of the bank's approach, since it received reports from the bank each quarter which made crystal clear what approach the bank was taking."

The timing of the suit is striking, coming less than two weeks before the inauguration of President-elect Donald Trump, a Republican real estate mogul who plans to scale back regulations tightened after the financial crisis led to government bailouts of companies including Bank of America and Citi.

Many of Trump's picks for regulatory and advisory posts have come from Wall Street, including hedge-fund manager Steve Mnuchin, the Treasury Secretary nominee; and Gary Cohn, the former Goldman Sachs COO whom Trump asked to head the National Economic Council.

Still, FDIC Chairman Martin Gruenberg, an appointee of President Barack Obama who was confirmed by the Senate in November 2012, has said he plans to serve out the remainder of his five-year term.

"It is surprising to me that what essentially is an administrative matter that should have been resolved through continued discussions with the bank has resulted in litigation," said Michael Krimminger, another of the bank's attorneys. Krimminger spent more than two decades at the FDIC, including a stint as general counsel. 

The pivotal question in the case is "on the FDIC's rule-making processes and the interpretation of what it claims to be a straightforward regulation," Krimminger said in a statement. "In my view, the FDIC's position in this instance is erroneous."

While the expense shouldn't affect the bank's long-term operating performance, Kleinhanzl, the Keefe Bruyette analyst, said it would reduce his estimate of the company's book value this year by at least 4 cents a share.

"We have concerns that Bank of America has now had another issue with calculating regulatory ratios or metrics," Kleinhanzl added, "but our expectation is that this will be the last of those issues."

In 2014, the bank had to resubmit its stress tests to the Federal Reserve because capital ratios were misstated. The gaffe was a setback for CEO Brian Moynihan, who has worked to rebuild Bank of America following costly financial-crisis acquisitions by his predecessor that forced the company to accept a $45 billion government bailout.

Bank of America's stock has climbed 3.8% to $22.94 this year as investors bet the company and its rivals will benefit from de-regulation under Trump. That outpaces a gain of 1.3% by the broader S&P 500

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