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Summary

  • It is announced that BAC will pay ~$17 billion to the Department of Justice and to consumers to settle its well-publicized shoddy mortgage practices.
  • BAC stock was up on Thursday on the news (8.21), suggesting investors are looking ahead to a potential buying opportunity.
  • Certain bright spots appeared in BAC’s Q2 earnings results, including increased volumes in retail debit and credit cards; and business segments, brokerage assets, and global banking gains.
  • Alongside the recovering US economy, we are cautiously neutral and no longer negative on BAC’s prospects moving forward in 2014.

Bank of America (NYSE:BAC) will pay about $17 billion to the Department of Justice and to consumers to settle its well-publicized shoddy mortgage practices.

The bank, headquartered in Charlotte, North Carolina is the second biggest bank in the U.S. by assets and twenty-first largest by revenue. The DOJ has accused the bank of packaging substandard mortgages into securities and then selling these to investors. It's believed that these low-grade mortgages precipitated or aggravated the financial crisis in 2008.

Biggest Settlement in US History

The fine that Bank of America will have to pay is the biggest settlement in United States history between the government and a single corporation.

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Although the full scope of the investigation into the bank have not yet been made public, Bank of America, like the other three major banks in the US - JPMorgan Chase (NYSE:JPM), Citigroup (NYSE:C), and Wells Fargo (NYSE:WFC)- has been penalized for packaging poor-quality mortgages into securities. In fact, the quality of these offerings was so shoddy that they did not even meet the bank's own quality standards. Authorities allege that after the housing market collapsed, these securities plummeted in value and created the financial crisis six years ago.

By contrast, the government fined JPMorgan $13 billion a year earlier. The reason Bank of America had to pay more than the largest US bank is because it had issued far more mortgage securities.

The $17 billion penalty, which equals the bank's profits for the last three years, will be paid in the form of money and consumer relief.

Negotiations Will Help Consumers

During the negotiations, officials at the Department of Justice specified the need for the bank to play a role in providing consumers damaged by the toxic mortgages with some form of relief. Consequently, the bank will only pay around $10 billion in cash with the remaining $7 billion going to provide direct consumer aid.

The $7 billion will go to help homeowners, who owe a larger amount than their homes are actually worth. It will also go to help those who risk losing their homes, because they can't afford to pay their mortgages. Thus, the money will go to lower homeowner's principal or it will go to lower customer's monthly payments.

Additionally, money will go to tearing down blighted neighborhoods, the result of abandoned homes, which has been a tremendous financial burden to the municipalities.

Besides paying for its past mistakes, the bank must also admit that it misled consumers on the quality of its mortgage-backed securities, primarily through its Merrill Lynch and Countrywide Financial acquisitions.

Countrywide Financial and Merrill Lynch: Two Plum Deals Turned Sour

A principle reason why Bank of America was able to turn out more mortgage securities was because the bank had acquired Countrywide and Merrill Lynch in 2008. At the time, these were considered impressive deals. The acquisitions placed the bank as one of the major players in the game. However, as events later showed, these plum acquisitions proved to be a tremendous liability. In retrospect, Countrywide and Merrill hamstrung Bank of America through its exotic loans and packaging of bad loans. The bulk of the mortgage securities now attributed to Bank of America came from Countrywide and were packaged by Merrill. These toxic mortgages were later credited for contributing to the financial crisis in a significant way.

CEO Views Deal with a Sense of Relief

Despite this landmark fine, Chief Executive Brian Moynihan sees it as the last of many of the heavy fines that the bank has had to pay since the financial crisis. Although shareholders had been bracing for the fine, the total amount came as a shock. In April of this year, it was believed that it would be about $12 billion, a shade less than JPMorgan had historically paid. This would have represented the loss of the bank's 2013 profit, which was 11.43 billion.

Brian Moynihan has been wrestling with litigation issues for most of his four-and-a-half year tenure as president and chief executive. On December 16, 2009, he was elected to board of directors. On January 1, 2010, he took office of one the third largest company in the world, operating in all 50 states and in more than 40 countries. He believes this deal is the last big crisis the bank may have to pay for after shelling out an estimated $60 billion in legal costs over the past few years.

Victory for DOJ, Buying Time Could Finally Be in Sight for BAC

This large fine represents one more legal victory for the Department of Justice in its relentless mission to make the big banks accept responsibility for harming the economy by pushing shoddy mortgage securities.

Meanwhile, for Bank of America, it represents one more settlement that it has had to pay for its role in precipitating the economic crisis in 2008. The bank's litigation costs and regulatory fines have depressed earnings and alienated shareholders.

Certain points in BAC's recent Q2 earning results indicate recovery for the ailing giant:

· Retail debit and credit card volumes up (4% from the same period last year and 8% from last quarter);

· BAC's business segments generating 24% return on capital;

· Brokerage assets up 26% on a year-over-year basis to $105 billion; and

· Global banking earnings growth of 4% from the same period last year and up 9% over the first quarter of 2014 with an 18% return on capital.

These positive indicators are alongside a recovering US economy (home equity origination up 30% in the quarter).

Thursday's stock performance following the news of the (albeit large) settlement is positive.

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With these points in mind, we are cautiously neutral and not negative on BAC moving ahead after its settlement.

Shareholders must still be cautious because the settlement does not preclude any criminal charges against the bank or its employees which if they occurred, would not be good for the BAC stock price.

We invite readers wishing to join the discussion on Bank of America to click +Get real time alerts above the title of this article.

Source: Bank Of America And Merrill Lynch Avoid Death Penalty