Bank Of America Profits Crash; Now It Needs To Settle With The USA Before It's Sued

Jul.16.14 | About: Bank of (BAC)

Summary

The longer BAC waits to settle with US regulators for fraudulent mortgage securities practices, the greater risk it takes on for shareholders of an even more expensive lawsuit.

While a settlement will likely cost at least $12 billion, a lawsuit could cost closer to $20 billion. BAC has been putting away additional billions for this purpose.

Either outcome will significantly strain resources and growth momentum at a time when peers, like WFC, are moving forward.

Given poor results, penny dividends, inconsistent results, a negative public image, and a staggering list of other fines and fees YTD, we see no reason to invest in BAC.

With Citigroup (NYSE:C) finally working out an agreement with the Department of Justice, Bank of America (NYSE:BAC) is next in line to settle for fraudulent mortgage securities practices during the financial crisis.

BAC, however, is reluctant to settle; offering figures ~$5 billion below what US regulators are asking.

The longer BAC draws out its settlement, the greater risk it takes on for shareholders, who stand to lose billions more in a law suit.

A $12 Billion Baseline

Bank of America is one of the biggest banks in the United States. Relative to other banks in the banking industry, it has a capitalization of $161.73 billion, an enterprise value of $532.74 billion, and an operating profit margin of 15.38%.

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Currently the bank, led by Chief Executive Brian Moynihan, is in talks with the Department of Justice (DOJ) to pay at least a minimum of $12 billion. This will settle civic probes by the DOJ and various states where the bank allegedly participated in shoddy mortgage practices. It's estimated that $5 billion of this amount will provide consumers relief, which could come in the form of reduced principal and lowered monthly payments. Additionally, some of this money will go toward removing blight from impoverished neighborhoods.

Since the $12 billion the bank has agreed to pay is actually a baseline figure, it's possible that as the negotiations heat up, Attorney General Eric Holder may press the bank to pay much more.

Last year, JP Morgan paid the government $13 billion to settle mortgage security allegations of a similar nature, and it is expected that Bank of America's fines will surpass this landmark figure.

Risks of a Lawsuit

If BAC continues its reluctance to settle with US regulators, it bears increasing risk for its shareholders of an even more costly lawsuit. Adding billions its reserves for this general purpose has already taken away from what it could give back to shareholders in the form of dividends.

BAC has not raised its dividend payout above a penny since 2008.

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Additional Settlement With AIG For $650 million Announced Today

BAC also recently resolved private lawsuits with AIG for the same reason--dishonesty about the quality of mortgage securities BAC sold.

These huge penalties are certainly not insignificant. While they increase BAC's financial burden, they also continually tarnish the bank's public image.

A Significant Strain
Although Bank of America is a huge organization in the banking sector, even a minimal settlement of $12 billion will put a huge strain on the bank's resources and growth momentum. The settlement figure now looks much closer to $17 billion.

It's highest recent profit was actually below that figure. Last year, the bank earned $11.43 billion, the highest profit in six years.

BAC has already seen rising expenses this year, resulting in hundreds of layoffs at its Charlotte headquarters.

Strangely, CEO compensation for Brian Moynihan has increased by17%--which amounts to roughly half of the Charlotte firings.

Will BAC Write The Check Sooner - Or Later?

Luckily for Citigroup, banking executives headed off an embarrassing lawsuit by settling only hours before Justice Department's number three prosecutor Tony West was about to sue. Unless Bank of America writes a big check soon to the United States Of America, Mr. Holder may very well give the nod to go ahead and sue them.

Today's Results: No Visible Reason For Investing in BAC in 2014

Now, that the Citigroup case is out of the way, the government is targeting Bank of America. With the momentum built from their success with Citigroup, unless Bank of America is able to come up with an agreement that the government considers fair, the North Carolina-based bank faces the risk of being sued.

BAC reported earnings today, missing Q2 profits 43%, largely due to the enormous legal charges detailed above, and--understandably--fewer mortgage originations. While the bank did beat revised earnings estimates by 12 cents, earnings and revenues were significantly lower than last year.

With many other legal fees and penalties already dragging down the mega-bank in 2014, an additional $12-$17 billion will be a tough blow from which to recover-particularly while competitors Wells Fargo (NYSE:WFC) and Goldman Sachs (NYSE:GS) are making forward strides. WFC in particular is picking up more mortgages.

With inconsistent performance YTD, minimal dividends, and a rapidly declining public image, we see no apparent reason to invest in BAC common stock in the second half of 2014.

It is negligent on BAC's part to draw out its largest settlement longer than necessary, straining already frustrated investors, and risking even larger losses.

Along with WFC (noted above), we are increasingly positive on Heritage insurance (NYSE:HRTG) as alternatives in the financial sector.

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Disclosure: The author is long HRTG. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.