Case Studies in Liquidity Risk: Bank of America

Risk analysts often forget that liquidity risk is the symptom that a firm has some other severe disease, be it credit risk, market risk, interest rate risk, fraud or something else. Default becomes inevitable when it becomes apparent that an institution cannot liquidate its assets with sufficient speed or volume to meet cash needs from liabilities that have been withdrawn (in the case of deposits) or which will not be rolled over (commercial paper, bank lines, bonds, cancelled insurance policies and so on).  For an institution which hasn’t failed, data from institutions that have failed or which have had “near death experiences” usually provide more insights on liquidity risk than the institution’s own history of liability amounts and costs.

This blog features the funding short-falls at Bank of America during the credit crisis for exactly that reason.

Under the Dodd-Frank Act of 2010, the Board of Governors of the Federal Reserve was required to disclose the identities and relevant amounts for borrowers under various credit facilities during the 2007-2010 financial crisis.  These credit facilities provide perhaps the best source of data about liquidity risk and funding shortfalls of the last century.  This data is available for purchase from Kamakura Corporation and is taken from the Kamakura Risk Information Services Credit Crisis Liquidity Risk data base.

The data used in this analysis is described in more detail below. The data consists of every transaction reported by the Federal Reserve as constituting a “primary, secondary, or other extension of credit” by the Fed. Included in this definition are normal borrowings from the Fed, the primary dealer credit facility, and the asset backed commercial paper program. Capital injections under the Troubled Asset Relief Program and purchases of commercial paper under the Commercial Paper Funding Facility are not included.

This blog entry lists the borrowing by Bank of America that was identified by the Fed as “primary, secondary, or other extensions of credit” between February 8, 2008 and March 16, 2009.  Borrowings under this facility clearly represent a funding shortfall and an excellent measure of the degree to which liquidity was insufficient. A number of key events for Bank of America are noted in this recent blog:

van Deventer, Donald R. “A Credit Crisis Chronology Part 1 Through February 2008: This Time Isn’t Different,” Kamakura blog, www.kamakuraco.com, May 13, 2011.

Key dates for Bank of America are excerpted here:

August 24, 2007	Bank of America buys $2 billion in Countrywide Financial preferred stock (Source: www.ft.com)
October 15, 2007	Citigroup and Bank of America announce “CP rescue fund” (source: Bloomberg)
October 18, 2007	Bank of America writes off $4 billion in losses (source: Bloomberg)
November 13, 2007	Bank of America and SunTrust prop up money market funds (source: Bloomberg)
November 13, 2007	Bank of America says it will have to write off $3 billion in bad debt (Source: http://news.bbc.co.uk)
January 11, 2008	Countrywide announces sale to Bank of America (Source: Levin report, page 47).
July 1, 2008	Countrywide acquisition closes (Source: Wall Street Journal)
September 14, 2008	Bank of America announces acquisition of Merrill Lynch (Source: Wall Street Journal)

In analyzing Bank of America borrowings from the Federal Reserve, we have not included borrowings where the counterparty to the Federal Reserve was Merrill Lynch or Countrywide Financial.  They will be discussed in separate case studies. As we note below, the Federal Reserve used inconsistent naming conventions in the reports released to the public.  The analysis below is Kamakura’s best effort to consolidate loans to all Bank of America entities, which were listed in 3 different Federal Reserve districts, with the exception of Countrywide and Merrill Lynch. The primary, secondary, or other extensions of credit by the Federal Reserve to Bank of America during the period February 8, 2011 to March 16, 2009 can be summarized as follows:

Borrowing dates:	Continuous from September 22, 2008 with intermittent borrowings from June 19, 2008
Average from
2/8/2008 to 3/16/2009	$1.9 billion
Average when Drawn	$4.1 billion
Maximum Drawn	$13.0 billion
Days with Borrowings	186 days

Kamakura Risk Information Services version 5.0 Jarrow-Chava default risk models showed a cumulative 5 year default probability for Bank of America of 0.84% on January 14, 2008, the first business day after the announcement of the acquisition of Countrywide Financial Corporation.

By the beginning of Bank of America’s extended borrowings from the Fed, which started on September 22, 2008, Bank of America’s cumulative 5 year default probability had risen to 3.74%:

The pattern of total outstanding borrowings from the Federal Reserve shows a run-up to $12.32 billion on October 10, 2008, followed by a gradual decline of borrowings through January 2009. This was followed by a  surge in borrowings that began on February 17, 2009 and peaked at $13.0 billion on March 5, 2009:

Bank of America received a $15 billion capital injection under the emergency Capital Purchase Program on October 28, 2008¹. $10 billion was invested in Merrill Lynch under this program and was transferred to Bank of America on January 9, 2009, and an additional $20 billion was invested in Bank of America under the program on January 20, 2009, for a total investment of $45 billion. In addition to the capital injections and these borrowings (“primary, secondary or other extensions of credit” from the Federal Reserve), Bank of America sought support from the Commercial Paper Funding Facility run by the Federal Reserve on one occasion.  In a separate release available at the link below, the Federal Reserve lists Bank of America as issuing 3 month commercial paper in the amount of $14.93 billion on October 29, 2008:

Implications of Funding Shortfall Data

The Bank of America borrowings in the form of “primary, secondary, and other extensions of credit” were much smaller than the $208 billion in borrowings by AIG that were detailed in our May 16, 2011 blog. Nonetheless, the dramatic swings in borrowings by Bank of America show the difficulty in managing liquidity risks caused by credit problems at both the Bank itself and at its competitors.  The $14.93 billion in borrowings under the Commercial Paper Funding Facility, while less dramatic, is further confirmation that the liquidity risk and funding shortfall at Bank of America affected the holding company as well as its banking subsidiary.  In subsequent blogs, we will do case studies of Countrywide Financial and Merrill Lynch in order to understand Fed extensions of credit to those firms.

Background on the Federal Reserve Data

A summary of the Federal Reserve programs that were put into place and summary statistics are available from the Federal Reserve at this web page:

http://www.federalreserve.gov/newsevents/reform_transaction.htm

Today’s blog focuses on one set of disclosures by the Federal Reserve: primary, secondary and other extensions of credit by the Fed.  This includes direct, traditional borrowings from the Federal Reserve, the primary dealer credit facilities, and the asset backed commercial paper program described at the link above.  These borrowings do not include commercial paper purchased under the Commercial Paper Funding Facility nor do they include the equity stakes taken by the U.S. government under the Troubled Asset Relief Program.

Kamakura took the following steps to consolidate the primary, secondary and other extensions of credit:

• From www.twitter.com/zerohedge Kamakura downloaded the daily reports, in PDF format, from the Federal Reserve on primary, secondary and other extensions of credit from February 8, 2008 until March 16, 2009, approximately 250 reports in total
• Kamakura converted each report to spreadsheet form
• These spreadsheets were aggregated into a single data base giving the origination date of the borrowing, the name of the borrower, the Federal Reserve District of the borrower, the nature of the borrowing (ABCP, PDCF, or normal), the maturity date of the borrowing, and (in the case of Primary Dealer Credit Facility) the name of the institution holding the collateral.
• Consistency in naming conventions was imposed, i.e. while the Fed listed two firms as “Morgan Stanley” and “M S Co” Kamakura recognized to the maximum extent possible that they are the same institution and used a consistent name
• To the maximum extent possible, the name of the ultimate parent was used in order to best understand the consolidated extension of credit by the Fed to that firm.

For information regarding the Kamakura Credit Crisis Liquidity Risk data base, please contact us at info@kamakuraco.com.  Please use the same e-mail address to contact the risk management experts at Kamakura regarding how to simulate realistic liquidity risk events in the Kamakura Risk Manager enterprise-wide risk management system.

Donald R. van Deventer
Kamakura Corporation
Honolulu, Hawaii
May 17, 2011

© Copyright 2011 Donald R. van Deventer. All Rights Reserved.

¹ Source: U.S. Treasury, Office of the Special Inspector General of the Troubled Asset Relief Program, “Emergency Capital Injections Provided to Support Bank of America, Other Major Banks, and the U.S. Financial System,” October 5, 2009.