In the wake of past mistakes in the handling of mortgage securities, Bank of America Corporation (NYSE:BAC) has agreed to pay billions of dollars to settle litigation brought by U.S. regulators. This is just the latest in a string of punitive settlements arranged by mega banks in the United States to put banking problem mistakes behind them. The announcement is expected to cut the company's profits by $3.7 billion dollars before taxes.
The Federal Housing Finance Agency began investigating Bank of America late last year after its successful conclusion of the case against J.P. Morgan Chase (NYSE:JPM). With considerable evidence of BAC's wrongdoing on the mortgage security sales to Fannie Mae and Freddie Mac, the outcome was merely a question of "how much" not "what if." The company has had warning of the possible outcome and has had time to prepare for the financial drag on its books. However, this may not yet be the end of BAC's problems.
The BAC Settlement
The settlement covers faulty mortgage securities that were purchased between 2005 to 2007 by Fannie Mae and Freddie Mac. See our previous article on the topic here. The deal with the Federal Housing Finance Agency was finalized this week on March 26, 2014 to settle lawsuits against Bank of America's subsidiaries Countrywide and Merrill Lynch alleging misrepresentation about compliance with certain standards required for mortgage loans. Bank of America has agreed to $6.3 billion to Fannie Mae and Freddie Mac, as well as another $3.2 billion for other residential mortgage-backed securities at fair market value.
The magnitude of the settlement amount is expected to negatively impact BAC's first quarter 2014 profits. An income reduction of about 21 cents per share is predicted by analysts. This number is about 3/4ths of what analysts expected in profits before the settlement announcement. Adding to the negative gain is the $15 million the company has agreed to pay to settle another suit with the New York State Attorney General in regard to the acquisition of Merrill Lynch in 2009.
The current announcement is only the latest of settlements Bank of America has had to work into its budget over its errors in the past. A previously settled case reduced the company's reserves in the amount of $8.5 billion.
CEO Brian Moynihan noted that the company held $14.1 billion in reserves for these legal issues. The new settlement goes well beyond that amount and could keep the company in a pattern of slower growth in the near future.
We recommend BAC shareholders take some profits now - as this embarrassing series of scandals, present turmoil, and reduced outlook do not suggest secure, consistent gains in 2014.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.