According to the Charlotte Observer,

Bank of America has agreed to pay a $7.65 million civil penalty to settle charges resulting from the Charlotte bank’s multibillion-dollar miscalculation of its capital ratios, a regulator said Monday.

The penalty announced by the Securities and Exchange Commission comes after the bank disclosed in April that it had incorrectly accounted for a type of debt it inherited in its 2009 Merrill Lynch acquisition. Bank of America reported the error to the SEC when the bank discovered it in April.

This is a big deal and there are consequences when a publicly traded company misrepresents its capital ratios.  An even bigger concern is when that publicly traded company is a bank, because it must comply with more regulations than other industries.  So what exactly are capital ratios and why are they so important to warrant a multimillion dollar fine?  I’ll explain.

The analysis of financial statements for publicly traded companies happens daily.  Financial statements include both dollar figures and percentages/ratios.  Percentages, often called ‘common-size ratios’, show more clearly than dollar figures the most important financial trends experienced by a business.  Percentage-composition ratios control for differences in the size of the firm, allowing investors or business partners to compare a particular business with other firms and with the industry as a whole.

In this case BofA incorrectly reported debt.  I do not know the specifics of the accounting error, but below are some common debt capital ratios that are used when a lender is concerned about how much debt a borrower has taken on in addition to the loan being sought.  Key financial ratios, such as the ones listed below, are used to analyze any borrowing business’ credit standing and use of financial leverage.

Leverage ratio = total liabilities / total assets

Capitalization ratio = long-term debt / total long-term liabilities and net worth

Debt-to-sales ratio = total liabilities / net sales

The accounting error has led Bank of America to not only be fined by the SEC, but also cost shareholders a dividend increase.  All business decisions are made to maximize payout to the shareholders, in this case shareholders didn’t profit very much.

The error stalled Bank of America’s plan to raise its quarterly common stock dividend from 1 cent per share, where it had been stuck since the financial crisis.

In March, the Federal Reserve OK’d the bank’s plan to increase the dividend to 5 cents. But that was put on hold after the capital error discovery, which caused the bank to resubmit its request for the dividend increase to the Fed.

In August, the bank announced it had again won Fed approval to raise the dividend to 5 cents. The bank also said it would scrap plans to buy back $4 billion in common stock.

Bank of America shares fell less than 1 percent Monday to $17.01.

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