Many investors believe that Bank of America (BAC) worked through the worst of the litigation in February 2012 when the bank paid $11.8 billion to settle the claims of abusive mortgage practices that were brought on by the nation's 50 attorney generals. Other banks that were included in $25 billion settlement included Wells Fargo (WFC), JPMorgan Chase (JPM), Citigroup (C) and Ally Financial. At the time of the settlement, investors were relieved and Bank of America's stock spiked higher. This happened despite warnings from people in the know that warned the public that the bank's litigation problems were far from over. The National Association of Consumer Advocates' executive director Ira Rheingold said, "The bottom line about this settlement is, it's okay, it's a step forward, it's a step in the right direction. But let's not kid ourselves, there's a hell of a lot more that needs to be done."
What's Next For BAC?
Looking forward, Bank of America faces litigation on three fronts. The first is with federal prosecutors who are accusing the bank of fraud. The second is with regulators who claim that the bank conned investors into buying bad mortgage securities, and the third is with investors who are seeking to make the bank buy back bad soured loans.
Bank of America has worked hard and paid dearly in an attempt to get these legal problems behind it. Since 2010, it has paid claims totaling more than $40 billion. However, new claims mostly as a result of abuses by its Countrywide Financial division continue to plague the bank. One of the most troubling claims was finalized on January 7th, when Bank of America entered an $11.6 billion settlement to end Fannie Mae's claims that the bank improperly sold it mortgages that later soured. Bank of America will buy back the loans for the value of their outstanding principal. The bank said the pact covers loans with a current balance of about $300 billion. The agreement largely covers the $11.2 billion of claims that government-owned finance company, Fannie Mae, had against the bank, which represented about 44% of the bank's total pending claims at the end of the third quarter. This was good news for the bank, because the cost of the claims could have been much higher.
Bank of America still has several other large claims that have yet to be resolved. The claims include a separate settlement with Fannie Mae over foreclosure delays that will result in Bank of America paying $1.3 billion.
On October 24th, Bank of America was sued by Federal prosecutors for $1 billion. The suit alleged that the bank's former Countrywide unit put together a mortgage scheme called the "Hustle" in which "In order to increase the speed at which it originated and sold loans... Countrywide eliminated every single checkpoint on loan quality and compensated its employees solely based on the volume of loans originated," The settlement in this case could easily exceed $1 billion because the Justice Department sued the bank under a law that could allow roughly triple the damages incurred by taxpayers.
On August 28th, Bank of America asked a Federal court to throw out a lawsuit by its shareholders, which alleged that the bank concealed a $10 billion fraud case brought by American International Group (AIG). The AIG lawsuit is still pending, and Bank of America has estimated that it may have to pay out as much as $4.1 billion more in litigation cost than the unspecified sum that it had set aside.
It now appears that as a result of Countrywide's fraudulent mortgage activities that the $40 plus billion that Bank of America has agreed to pay in settlements will not be the end of the litigation expenses that will be assessed against it. The bank still has a number of pending claims, and its potential legal liabilities are unclear, but there is little doubt that they will be in the tens of billions.
Because of its potential litigation expenses and the following reasons, I think that the stock of Bank of America will take a hit.
Consider the following:
Bank of America's stock has rallied based on the belief that it had put its subpar mortgage problems behind it. However, as the lawsuits against the bank proceed, investors will come to realize that the bank's subpar mortgage problems are a long way from over.
Over the last 52 weeks, Bank of America's stock price is higher by 95%, and I believe that the stock is overbought and ready for a pullback.
Large banks like JPMorgan Chase or Wells Fargo have reported steady or higher net income for the last three quarters, while in the fourth quarter, Bank of America's net income fell to $340 million from $2.4 billion in the prior quarter.
Despite the fact that Bank of America has made efforts to clean up its balance sheet, an analysis of its lawsuits and company filings indicates that it still holds $417 billion in troubled mortgage-backed loans from Countrywide Financial.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.