The litigation costs, settlements, penalties and fines have been the Achilles heel of the banking sector over the past few years. The financial crisis of 2008 brought some of the biggest banks to their knees. Most of the banks have made substantial recovery; however, the threat of lawsuits and payments to the aggrieved parties still exists. Bank of America (BAC) is also one of these major players that have paid billions in settlements and fines over the past few years. However, there are still some settlements and litigation battles that the bank has to deal with over the next few quarters. The most important of these battles is the $8.5 billion settlement arising from the Countrywide Financial assets. The settlement was challenged by American International Group (AIG) - as a result, the case was in the court, and the judges have ruled in favor of BAC, allowing the bank to settle its liability. Let's look at the implications of this decision.
Background to the Case
The dispute goes back to 2011. A group of investors claimed that they were hurt by the mortgage securities sold by the bank. In an effort to deal with the issue, Bank of America agreed to pay $8.5 billion in settlements to these investors. However, some of the investors were not satisfied with the terms of the agreement and demanded more in payment; mainly AIG was pushing for a higher payment by Bank of America. Another aggrieved party was the pension fund for the Chicago police department that also had some reservations about the settlement. AIG accused the trustee, The Bank of New York Mellon (BK), of being biased towards BAC due to the business relationship of the two banks. AIG argued that The Bank of New York Mellon was not able to present the interests of the aggrieved parties properly and did not push for a larger settlement.
As a result, AIG took the issue to the court and argued that the settlement should be stopped. However, in January, Judge Barbra Kapnick approved most of the settlement except for a portion about the modified loans. AIG took the case to Justice Saliann Scarpulla in order to halt the settlement. Justice Saliann Scarpulla has also ruled in favor of Bank of America, and the bank can go forward with the settlement. However, AIG is portraying the decision as a partial win, as the judge has not taken away their right to further argue their cause, and the group plans to file the appeal at an appropriate time. However, for now, it looks like the case is settled, and the bank can go ahead with the settlement.
Implications of the Decision
As I have mentioned in my previous article, this settlement was the biggest threat for Bank of America. Some writers went as far as saying that the bank could end up paying close to $60 billion in settlements if the decision goes against Bank of America. As a result, the stock price has been under pressure. Now that the decision has come in favor of the bank, we will see rapid upward movement in the stock price, in my opinion. The remaining litigation matters are not big for the bank, and this settlement represents the biggest payment by Bank of America in the mortgage securities fiasco.
If the decision would have been against Bank of America, the stock would have seen a substantial decline in price as the investors are very sensitive to these issues since the financial crisis of 2008. However, as the settlement goes through, the bank will continue to deal with its legal matters, and it looks like these issues will be handled completely over the next 12-18 months. JPMorgan's (JPM) management has adopted a very effective strategy when it comes to dealing with these matters. Instead of going to war, JPM has been settling and making payments quietly to claiming parties and the government in shape of fines, which has kept the bank out of the spotlight and bad press.
Based on the progress in the business segments, Bank of America is well positioned to grow. The deposits are increasing for the bank. Iit has one of the most efficient loans-to-deposits ratio (0.84), meaning the bank is using its deposits well. Also, the expected rise in the interest rate and the growing economy will result in widening the spread for Bank of America. As the litigation issues are resolved, the stock will start to move up higher. My optimism about the bank mainly stems from its strong asset base, efficient use of its resources and increasing deposits. Most importantly, I believe the biggest threats to the bank in the shape of legal settlements are being resolved, which should have a positive impact on the stock price.