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When many of the large financial institutions are moving ahead to meet the new capital rules by 2019, Bank of America Corporation (BAC - Analyst Report) is falling behind due to significant pressure on its capital position. Though the company is making every effort to save itself, it could be a major threat for the second largest U.S. bank by assets.

BofA hopes to fulfill the regulatory capital requirement through organic means, aided by the sustained shedding of non-core assets. Also, there is a high chance that the company would need to issue some shares to raise capital.

Last month, the Fed had announced that 31 banks (with $50 billion or more assets) will have to bear another round of stress tests in the upcoming weeks to prove their financial strength to confront another recession. Additionally, six big U.S. banks — Citigroup Inc. (C - Analyst Report), BofA, JPMorgan Chase & Co. (JPM - Analyst Report), Morgan Stanley (MS - Analyst Report), The Goldman Sachs Group Inc. (GS - Analyst Report) and Wells Fargo & Company (WFC - Analyst Report) — will have an even higher stumbling block to clear as they have significant exposure to the stressed European countries — Greece, Ireland, Italy, Portugal, and Spain (PIIGS).

The main aim of the stress test is to demonstrate that the banks are financially sound to address potential losses over the next two years under several stressful scenarios.

The Fed had also stated that only those companies that successfully confirm their core capital to remain above 5% of risk-weighted assets under the stressful scenarios will be given permission to raise dividend. BofA will be submitting its capital plan in January 2012 for the fourth round of stress tests.

According to Reuters, BofA could opt for selling off its Indian back-office processing operation, or get rid of real estate holdings and private-equity investments to boost capital levels.

Since last year, BofA has been trying to remove a large number of non-core assets to boost capital position and strengthen its balance sheet in order to reinstate dividend hike and meet Basel III capital requirements, without diluting shareholder value. Besides, BofA has been selling its stake in China Construction Bank (CCB) at regular intervals, liquidating its non-core assets.

Post its latest action on CCB, BofA will still have 2.1 billion shares or about 1% stake in the company. The sale of the remaining stake is restricted till the end of August 2013.

Further, the share sale will not put an end to the strategic-assistance agreement between BofA and CCB. This agreement, effective from 2016, requires BofA to provide strategic help to CCB in consumer and private banking, corporate and institutional banking, as well as business training.

Furthermore, the company has also begun trimming its workforce in order to lower its operating expenses by $5 billion through the end of 2014.

Earlier this month, BofA agreed to sell its Designated Market Maker (DMM) business on New York Stock Exchange (NYSE) to global market maker, Getco LCC. BofA’s decision to move away from its market-making operations was a part of its strategy to concentrate on its core banking business. Concurrently, BofA planned to close down its Brazilian private banking business and trench nearly 40 employees.

We do not see an end to this non-core divestiture in the recent future. After BofA’s plan to boost dividend in the second half of 2011 was turned down by the Federal Reserve in March this year, it believes divestitures are the best way to shore up capital strength and fortify its balance sheet.

If BofA fails the test, it will have to take extra initiatives to raise new capital to meet the requirements. This will obviously not be good for the company as it has been suffering from lower revenues and higher operating expenses.

According to the source, purchase of Countrywide Financial in 2008 came up with a bunch of problems for BofA. The company bought the mortgage lender for $2.5 billion in 2008, and has recorded more than $30 billion in losses from bad loans, mortgage-backed securities claims and lawsuits linked to Countrywide Financial. Moreover, last week, BofA settled civil charges amounting to $335 million, which Countrywide categorize against minority homebuyers.

BofA is trying to get rid of troubled mortgage assets and settle lawsuits and other mortgage-related claims. Further, the bank is looking forward to the settlement with state attorneys general and federal officials related to investigation of foreclosure practices.

The bank is facing a number of challenges in the fourth quarter of 2011 and is striving hard to retain its position. Though the bank is moving ahead with options, it has the belief that it will meet all regulatory requirements, sooner than latter. BofA was one of the biggest victims of the 2007 housing bubble with share price plummeting 85% since then. Despite taking several restructuring initiatives, the company has still not been able to come out of the crisis. 

BofA has relentlessly tried to realign its balance sheet in accordance with the regulatory changes post meltdown to remain afloat. In fact, BofA remains committed to shed its non-core assets, even after repaying the bailout money it had taken as part of its participation in the Troubled Asset Relief Program.

BofA currently retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. Moreover, considering the fundamentals, we are maintaining a long-term “Neutral” recommendation on the stock.

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