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Mortgage Settlement Could Be Just the Purge B of A Needs

JUN 6, 2014 5:30pm ET
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Bank of America (BAC) could be one more big legal charge away from putting its mortgage woes with Uncle Sam behind it, and that charge could come as early as this quarter.

Granted, there are a number of "ifs" behind that prediction, but it's very plausible, according to conversations with analysts on Friday after several news organizations reported that B of A could be edging toward a $12 billion settlement with the Justice Department and state regulators regarding shoddy mortgages sold in the run-up to the financial crisis.

"This is really the last big mortgage-related litigation" for Bank of America, says Jason Goldberg, a senior analyst at Barclays Capital. "This would finally end what was a really bad chapter in the company's history so they can move on."

Investors seemed to shrug off the size of the settlement, perhaps out of relief that the litigation from the financial crisis would finally be resolved. Shares of B of A rose 1% to $15.59 a share in light trading Friday. And bank executives have said they have built substantial legal reserves in preparation for this moment.

Yet there may be still be some pain ahead for B of A. Some analysts say the Charlotte, N.C., bank is still under-reserved and a settlement would likely eat up most of its second-quarter profits.

But it might be worth it.

Legal tab

Jeff Harte, an analyst in Chicago at Sandler O'Neill & Partners, says B of A is "within a few billion" dollars of being reserved for the settlement.

"This is the last big shoe left to drop," Harte says. "They're going to build more reserves this year, which the market is assuming would be the case."

B of A's Chief Executive Brian Moynihan and its Chief Financial Officer Bruce Thompson have said at industry conferences this year that the bank is adequately reserved. Still, some analysts say B of A has consistently under-reserved and takes more of a "pay as you go" attitude toward settlements.

It took a $2.4 billion charge in the first quarter that could cover any fine or penalty needed for the settlement. (Analysts grilled Thompson on a first-quarter conference call about the exact purpose of the $2.4 billion, which he would describe only as for "previously disclosed legacy mortgage-related matters.")

According to the news reports Friday, $5 billion of the settlement would go toward consumer relief. That likely would come out of existing reserves.

That would mean B of A would need roughly another $5 billion in reserves, if a settlement ends up being around $12 billion, analysts say. The bank may end up taking a charge in the second quarter to cover the balance of the settlement and leave it some cushion. Such a charge could cost B of A roughly 35 cents a share, potentially wiping out its second-quarter earnings.

It would be similar to the approach the company took in the first quarter, when the $2.4 billion charge contributed to a loss of $514 million.

Outsiders have complained about B of A's volatile quarterly swings in reserves and the bank's inability to put an end to mortgage-related litigation. It has announced more than $22 billion in settlements already (see chart).

In March, B of A agreed to a $9.5 billion settlement with the Federal Housing Finance Agency to resolve lawsuits alleging it misrepresented the quality of loans packaged into securities that were bought by the government-sponsored enterprises. It agreed to pay $6.3 billion in cash to Fannie Mae and Freddie Mac and to buy back $3.2 billion in bad loans.

To be sure, predictions about what the new settlement could do to upcoming quarterly earnings depends on it getting done and on the final figure agreed to.

B of A and some analysts dispute that the tab for a settlement with Justice and state attorneys general in California, New York and New Jersey would be as high as $12 billion, a figure The Wall Street Journal cited on Friday. In April, Bloomberg reported that federal and state prosecutors were seeking more than $13 billion from B of A to settle the civil charges that the bank misled investors about the quality of mortgages sold primarily by its Countrywide Financial unit, which was acquired in 2008.

Of course, the government is known for throwing out large dollar figures so it can extract more money from banks in its negotiations. B of A's own proposal to settle the DOJ probe is said to have been lower than $12 billion. B of A also is pushing for more "soft money" that would come from consumer relief such as principal writedowns and loan modifications.

"Overall, investors like that it's just one more thing done," says Erik Oja, a U.S. banks equity analyst at S&P Capital IQ. "It's a $12 billion step toward some sort of clarity."

But he cautioned that litigation risk has tended to stick to B of A more than any other bank and that calculating its reserves has been tricky.

"They say they're more than half-way there, but even that is not quantifiable. It just goes on," Oja says. "We're getting to eight years since the height of the financial crisis, so it should get a bit easier now. They've been paying down this thing for a while."

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