Late last year JPMorgan (NYSE:JPM) had $13 billion of shareholder capital confiscated by an overzealous Justice Department under the guise of "consumer protection." In essence, the administration settled with JPM over the sins of companies it eventually acquired but that it, meaning JPMorgan, had nothing to do with at the time. I argued that this set a disturbing precedent as it meant that the government was free to use all large banks as its checking account for the foreseeable future. Today, we've got some proof that this is coming true as Bank of America (NYSE:BAC) is now having its shareholder capital confiscated.
While it's currently unclear why BAC is being targeted, other than because "that's where the money is," it means BAC shareholders will be out another $13+ billion on top of the other billions upon billions of dollars that have already walked out the door and into attorney and government hands in the past few years. I'm tired of a government that can't pay its own bills taking from private businesses but the fact is that this is the way of things while this administration is in power so we must deal with it.
What does it mean for shareholders? BAC put an additional $2.4 billion in its litigation reserves last quarter without telling us why. One can imagine it was for this settlement as BAC, no doubt, had some inkling this was coming down the pike. And with JPM's settlement already at $13 billion, that was an easy target for the administration to go after with BAC. Of course, $13 billion is a lot of money, even to a company the size of BAC, coming in at roughly 7.5% of total market cap. However, this is not a normal situation in terms of a legal settlement. When non-banks get hit with legal settlements, particularly huge ones, it is often an event that requires money to be set aside to pay claims after the fact. However, we all know that the large banks have been the legal system's cash cows for the past few years so BAC's already got a large litigation fund, although it doesn't disclose exactly what's in there for obvious reasons.
That's why the stock isn't plummeting on the news that this settlement is going to take place; BAC's already taken the hits in earnings prior to this. In fact, I'd argue that $13 billion is likely a largely expected number given JPM's settlement last year. And with BAC owning the vaunted Countrywide, famous for various misdeeds while it was independent, I would suggest that BAC would be fortunate to "only" get the same settlement as JPM. While I find it reprehensible that the administration would take this money from a private company and use it as tax revenue, that really doesn't matter because it's going to happen either way. We can only try to assess the damage as shareholders.
Speaking of tax revenue, BAC should be able to deduct whatever settlement comes down the pike and with BAC paying a 29% effective tax rate for 2013, that would imply a tax savings of about $3.8 billion. This effectively reduces the settlement from $13 billion to $9.2 billion, assuming BAC earns enough to offset this settlement. Of course, the actual numbers are likely to look different from this as there are many moving pieces but it is a good baseline to go off of. And with this much money on the line investors should not overlook the tax savings.
Finally, all this unpleasantness means that BAC can put this mess behind it. While nobody wants $13 billion to evaporate it means that once this settlement goes through, the administration will have to find some other way to continue to confiscate money from BAC. That will be more difficult to do as long as BAC structures the settlement in such a way that it cannot be sued for its mortgage mess again. This is a net positive for shares as it means that the damage is known at this point instead of the uncertainty shareholders were facing. At least we know now that BAC won't be hit for $20 billion or more, which would have been a huge negative for the stock as I doubt BAC's got that much in its litigation reserves; this way provides some clarity.
Shares are trading down in the pre-market about 1% as of this writing but once the initial shock of the sheer size of this settlement passes, I think shareholders will be pleased with the increased certainty it provides. The only thing we must watch for is next quarter's litigation expenses; if BAC didn't have $13 billion in its litigation fund, it means more losses are coming. I feel pretty comfortable that won't happen after BAC added the $2.4 billion this past quarter but we'll have to wait and see.
Disclosure: I am long BAC. 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.