Bank of America Corp. is operating under a secret regulatory sanction that requires it to overhaul its board and address perceived problems with risk and liquidity management, according to people familiar with the situation.
Rarely disclosed publicly, the so-called memorandum of understanding gives banks a chance to work out their problems without the glare of outside attention. Financial institutions that fail to address deficiencies can be slapped with harsher penalties that include a publicly announced cease-and-desist order.
The order was imposed in early May, shortly after shareholders of the Charlotte, N.C., bank stripped Chief Executive Kenneth Lewis of his duties as chairman. Bank of America faces a series of deadlines, some at the end of July and others in August, these people said.
The company might get more time to complete some of the steps it is taking, such as reconstituting its board with a majority of new directors. Since early June, Bank of America has named four directors to its 16-person board, leaving the bank considerably short of the government's requirement.
The MOU is the most serious procedural action taken against Bank of America by federal regulators since the financial crisis erupted.
Citigroup Inc. has been operating since last year under a similar order with the Office of the Comptroller of the Currency, according to people familiar with the matter. The company recently has been negotiating with the Federal Deposit Insurance Corp. about entering into a similar agreement with that agency, these people say.
These people say the pact with the FDIC, which relates to the company's plans to shed assets and improve its governance, among other things, essentially reinforces a strategy already under way at the financial giant. But some Citigroup officials are hopeful that the agreement, which was negotiated largely by Chairman Richard Parsons, will help thaw the company's icy relationship with the FDIC.
Spokesmen for Citigroup and the FDIC declined to comment.
Tensions between Bank of America and government officials have been building for several months, most notably a warning to Mr. Lewis by then-Treasury Secretary Henry Paulson that the bank's management could be pushed out if it abandoned the deal to acquire securities firm Merrill Lynch & Co., staggered at the time by massive losses.
Wider margins from trading are expected to help Bank of America show a decent profit when it reports second-quarter results Friday. But the bank still is being hammered by troubled loans and other consequences of the recession.
In late January, the Federal Reserve and Office of the Comptroller of the Currency downgraded their overall ratings of the bank to "fair" from "satisfactory," according to people familiar with the matter. In a letter that was reviewed by The Wall Street Journal, the Fed criticized Bank of America's management and directors for being "overly optimistic" about risk and capital. The bank's capital position "was vulnerable" even before the Merrill deal, the Fed concluded, citing "acquisition activity" that included last year's takeover of mortgage lender Countrywide Financial Corp.
"Management has taken on significant risk, perhaps more than anticipated at the time the acquisition was proposed," a Fed official wrote in the letter, which accompanied the ratings downgrade and was sent days after the government agreed to $20 billion in aid to keep the Merrill deal on track. As a result, "more than normal supervisory attention will be required for the foreseeable future."
The Fed declined to comment. The OCC didn't respond to a request for comment. A Bank of America spokesman declined to discuss the ratings changes or memorandum of understanding, saying the bank isn't allowed by law to discuss any confidential supervisory actions or communications.
The downgrades led Bank of America to create what it called the Regulatory Impact Office, or RIO, a traffic cop in its Charlotte headquarters charged with making sure future regulatory demands were met. Since then, certain regulatory requests such as approval of asset transfers within Bank of America have been cleared through the office, according to people familiar with the situation.
The MOU surprised some Bank of America executives who hadn't expected federal regulators to issue such a formal rebuke. The bank responded swiftly, with six directors resigning since May 26. The departures include O. Temple Sloan Jr., Bank of America's lead independent director, and Jackie Ward, chairman of the board's asset-quality committee.
It is possible that regulators will allow Bank of America to count two directors who joined the board as part of the Merrill purchase to be considered "new," according to one person familiar with the discussions. Walter Massey, president emeritus of Morehouse College, who took over as chairman from Mr. Lewis, also is leading a continuing search for additional candidates.
Late last month, Chief Risk Officer Amy Woods Brinkley stepped down in what company officials described as a retirement. J. Chandler Martin exited this week from his post as enterprise credit and market risk executive.
A spokesman confirmed that Mr. Martin, who retired in March 2008 as treasurer after 27 years at Bank of America but returned to help with the Merrill integration, is no longer with the company. Mr. Martin declined to comment.
Banks that have disclosed they are operating under a memorandum of understanding include Colonial BancGroup Inc., a regional bank based in Birmingham, Ala., and Riverview Bancorp Inc., Vancouver, Wash., which has just 18 branches.