Bank of America (BAC) has again made itself conspicuous in the media with a new announcement of a settlement of a case regarding misconduct during the recent housing crisis. Bank of America took on these liabilities when it acquired Merrill Lynch in 2008 after the investment suffered a whopping $52.2 billion in mortgage write-downs and losses. Now, Bank of America is having to take the financial hit for actions Merrill took when it was an independent company.
New Fines For Bank of America
Bank of America has been involved in a string of settlements over past months, all stemming from its' misconduct during the years of the housing crisis in 2006 and 2007. These settlements have cost the company billions of dollars to payoff liabilities to Freddie Mac and Sally Mae, as well as a number of smaller fines that run into millions of dollars. Earlier in December 2013, they announced an agreement to pay $6 billion. The latest announcement has investors wondering where, and when, it will all end. See our prior reporting.
This settlement relates to certain actions of Merrill Lynch and an Evanston-based hedge fund called Magnetar Capital. At the heart of the case are financial transactions called collateralized debt obligations, a form of derivative that re-packages loans and offers them to a group of investors to share in the principal and interest income. Merrill is accused of allowing Magnetar to choose the components that made up the re-configured loans that were offered on the secondary market and did not disclose to investors that the company had significant influence on the selection.
The purpose of CDOs is to minimize the effect of any single mortgage default on a portfolio. However, during the mortgage crisis, many bad loans were bundled together increasing their impact. The number of bad loans that went underwater helped to create the mortgage crisis that occurred in 2007 and pulled Merrill Lynch down with it. The Magnetar deal came to light during an investigation by ProPublica in 2010, which won them a Pulitzer Prize.
The latest gut-punch to BAC is in the amount of $131.8 million settles the Securities and Exchange Commission case against Merrill's misconduct, which also included selling Auriga C.D.O. which benefited Magnetar in part and for delaying the recording of a number of trades. Both the number and nature of the charges makes it clear that Bank of America may continue to be under fire for the actions of Merrill's leadership into 2014.
We expect the Bank of America to continue to be under pressure in 2014 to pay fines and settlements to the United States of America and private investors.
This recent settlement is just one of a number of troublesome problems Bank of America is having to deal with at a time when its profits are already in doubt and their dividends are very low.
Although BAC understood its vulnerability to legal action when it took on Merrill Lynch, the company may not have put aside sufficient funds to deal with the ongoing settlements. These problems are certain to affect its bottom line and dividend payments to the shareholders in 2014.
We believe that investors should continue to take some profits in the mega banks and reallocate the money to banks like U.S. Bancorp (USB) which Goldman Sachs just added to their conviction list and Berkshire Bank (BHLB) which we have written about recently here.
Both of these financial institutions have good management and they pay their shareholders a solid dividend.