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BofA's Structured Products in Limbo: Third-quarter profit drop will lead to massive layoffs and bigger questions

Bank of America's steep 32% third-quarter profit drop has led to a shakeup in leadership and a reported plan for massive layoffs. Now it remains to be seen what becomes of the bank's structured products business, which is reeling from the summer's credit slump.

Gene Taylor, president of the bank's global corporate and investment banking division, is set to retire and approximately 3,000 employees will reportedly be laid off. Brian Moynihan, head of the bank's global wealth and investment management unit, is replacing Taylor. Chris Hentemann, who oversaw the bank's global structured products, also left on Oct. 19 and was replaced by George Ellison.

"While some of these changes are a direct result of our underperformance, others have been contemplated for a number of months as we looked at how we could operate more effectively," Chief Executive Kenneth Lewis said in a statement. He added that most of the company's operations are "performing quite well," but said, "We recognize that there are areas where we need to improve and are moving decisively toward that goal."

After Hentemann's departure, Jefferson Haralson, an analyst for KBF, warned of further shakeups at Bank of America. "I think over the next few weeks they're going to be evaluating everything very thoroughly," he said. "We are also in budgeting season for next year, so the combination of budgeting season and a disappointing business line could lead to significant expense reductions, and I would expect it to do that."

Among the big hits the bank took is a $527 million loss in structured products, mostly in collateralized debt obligations and mortgage-backed securities, and a $247 million markdown for leveraged loans. Lewis has already indicated that significant changes are on the horizon as Bank of America re-evaluates its business plans. "I would say the probability of changes and elimination of some businesses and infrastructure is very high," he said in a conference call last week.

The Charlotte, N.C. bank has gained notice for aggressively ramping up the investment side of its business to compete with the bigger players, but some analysts are now wondering whether it had the capabilities in place to manage volatility. "Significant trading losses in the third quarter put in question the level of risk taken at BofA," said Lori Applebaum, an analyst at Goldman Sachs.

It remains to be seen what becomes of Bank of America's mortgage securities business, which it had built up significantly over the years and which Ellison now takes over. "I think the long-term impact is this: The capital markets business is gone, and it's not going to return for some period of time," said Haralson. "Bank of America, in response to that, is going to scale back, take steps to reduce risk on the pieces it keeps, and then once it pinpoints the area of business it wants to be in, it's going aggressively into it and taking market share there."

Haralson said that BofA was "surprised by the volatility that the structured products business brought and wasn't satisfied with the hedging that was in place." He added, "There's going to be an internal review of their capital markets and investment banking business. There's going to be no more hobbies. It's going to be strategic and objective."

Dick Bove, an analyst for Punk Ziegel & Co., believes that Bank of America will veer away significantly from its capital markets plan, but doesn't foresee any massive change in the earnings direction of the company. "[Ken Lewis] has an historic bias against trading and trading-like operations," he said. "I think what he's done is he's gone into businesses that are perhaps against his bias, and he's discovered that those businesses are not showing the types of returns that he would consider acceptable."

Theses biases have now been reinforced, Bove said, and Lewis will begin cutting this business. "That means people are going to lose their jobs, and it means that Bank of America will allocate assets elsewhere."

The plan for massive layoffs, and the fact that BofA came at investment banking as an outsider, will likely thrust the company into the spotlight for all the wrong reasons. But Bove was quick to point out that almost all the big banks have suffered losses from the mortgage collapse, which would mean that almost none understood the investment risks they were getting into.

"It's clear that whatever systems were put in place in these organizations were faulty, and the heads of risk management for the banks did not know how to do their jobs properly," he said. "The industry experimented with this explosion of new product development without really understanding what would happen when these products were out there."

Bove expects there to be further changes in leadership at the banks, and he expects there to be changes in what products are developed. But the mistakes that have befallen the banks during the housing slump will likely happen again. "The money is out there," he said. "The system keeps creating more and more money. The Fed is going out of its mind to see how much money it can create every day. If you keep creating money, people are going to have to find places to put it."

Bove also questions whether changes at the executive levels will really translate into changes in how the banks will do business. The problem, he said, is that the companies essentially play a game of musical chairs, hiring people to do the jobs they were fired from at other banks. "So everybody will swing around to different companies and everybody will now figure out what they are doing, even though they've got the same guys that didn't know what they were doing at other companies," he said. "A lot of the same mistakes are going to be repeated, and it's going to happen in exactly the same fashion, and most of the same people are going to be doing it in the same way. It's a cycle."

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