BofA Likely To Report Q3 Loss Over Record $16.65 Billion Mortgage Settlement

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Bank of America (NYSE:BAC) finally inked a deal with a string of government agencies to substantially put its outstanding legacy mortgage-related issues to rest for a total cost of $16.65 billion. [1] The diversified banking group reached the accord with the Department of Justice (DoJ), SEC, FDIC, FHA, Ginnie Mae and Attorneys General of six states to settle all actual and potential civil liabilities related to the mortgage-backed securities sold by it and its acquired subsidiaries Merrill Lynch and Countrywide in the run-up to the economic downturn of 2008.

The deal follows months of negotiations between the regulators and Bank of America, and is the largest settlement ever by the DoJ with a single entity. The cash component of the deal is $9.65 billion, while the remaining $7 billion will be directed towards consumer relief. As a direct result of the payout, the bank will see a $5.3 billion reduction in pre-tax earnings for the quarter – likely enough to send the results for Q3 2014 in the red.

As the settlement clears a bulk of the banking giant’s legal backlog, investors cheered the news by sending Bank of America’s shares up by 4% over trading on Thursday, August 21. The bank’s improved legal outlook coupled with its ongoing cost-cutting initiatives as well as its decision to hike dividends for the first time since 2008 earlier this month lend support to our $18.50 price estimate for Bank of America’s shares. [2]

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Bank of America has the dubious distinction of being the bank with the greatest number of lawsuits filed against it in relation to unfair mortgage origination and securitization practices in the years leading up to the economic recession of 2008. An important reason for this was the bank’s decision to acquire Merrill Lynch and Countrywide at the peak of the recession – adding their significant legal liabilities to its own. But the bank has put in considerable effort over the years to put these issues behind it, and has entered into a series of multi-billion dollar settlements to get rid of the legal overhang.

The $16.65 billion settlement announced this week is by far the largest payout for the bank, and resolves almost all legal actions against the bank by U.S. regulators. Notably, this follows the similar $13 billion deal for JPMorgan (NYSE:JPM) last November (see Key Takeaways From JPMorgan’s Mammoth Settlement Of Legacy Mortgage Issues) and the $7 billion deal for Citigroup last month.

The $16.65 billion figure includes:

  • $9.65 billion in cash payments, of which
    • $5.02 billion is a civil monetary penalty to the federal government
    • $4.63 billion will be routed towards compensatory remediation payments
  • $7 billion in customer relief. Bank of America will channel this amount towards the worst-affected homeowners either directly (through principal reductions and delayed foreclosures) or indirectly (through various relief programs)

Besides criminal claims and claims against particular individuals, the only pending legal standoff between Bank of America and a U.S. regulator over mortgage-related issues is the lawsuit against Countrywide over its High Speed Swim Lane (HSSL) mortgages. The bank is currently appealing the $1.27 billion penalty it was ordered to pay by a federal district court last month. [3] You can understand the impact of the one-time payout on the bank’s share value by making change to the chart below.

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Notes:
  1. Bank of America Reaches Comprehensive Settlement With U.S. Department of Justice and State Attorneys General to Resolve Mortgage-related Litigations and Investigations, Bank of America Press Releases, Aug 21 2014 []
  2. Bank of America Increases Quarterly Common Stock Dividend to $0.05 per Share, Bank of America Press Releases, Aug 6 2014 []
  3. Bank of America ordered to pay $1.27 billion for ‘Hustle’ fraud, Reuters, Jul 30 2014 []