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Summary

  • BAC lost its fight with the DoJ on the company's mortgage settlement.
  • The removal of the overhang, however, sent shares soaring on the news.
  • The company is now free to focus its efforts on banking and making money for shareholders rather than constant litigation.

Well, it's finally over. We finally got some resolution to the seemingly never ending nightmare that was the ongoing saga with the DoJ on Bank of America's (NYSE:BAC) mortgage behavior during the crisis. After months and months and months of both sides dragging their feet and negotiating, we can finally put this unpleasantness behind us. This is perhaps the most drawn out litigation outside of the tobacco industry I've ever seen and the find was downright enormous. So what does it mean for BAC shareholders?

The first thing I'd like to highlight is the actual cost of the settlement. I've written on this subject a few times and each time, the expected price tag went up. First there was a proposed $12B offer from BAC to the DoJ to settle, then it was $13B, then I saw a $15B to $16B estimate and finally, we got news yesterday that BAC had completely given in and gave the $17B the DoJ wanted.

Thankfully, "only" $9.65 billion of the settlement is a cash payment so the damage to the balance sheet and income statement is more muted than one may expect from the headline. Since BAC was already reserved for some of this it is taking a $5.3 billion hit to pretax income in the third quarter which will reduce EPS by an estimated 43 cents. The rest of the money, more than $7 billion, will go to "consumer relief", or mortgage modifications, principal forgiveness and the like. What this has to do with anything is unclear but that is what the settlement calls for.

So where did the number for the final settlement come from? Nobody knows. The DoJ, as it did with Citi (NYSE:C) and JPM, picked a number out of thin air with no rhyme or reason for it. I think the main driver of BAC's number was to simply make sure it was larger than the $13 billion JPM paid to settle similar charges, but that's it. This is why I am so disappointed in BAC simply giving up and handing over so much money; there was no reason to pay this much. However, that fight has been lost and the DoJ got exactly what it wanted and not a penny less. I guess the kudos should go to the DoJ lawyers who bilked exactly what it wanted from BAC. I previously stated that I wanted BAC to fight the DoJ because I believed the lawsuit wouldn't stand up in court but, as it turns out from the reaction of the stock yesterday, that would have been a poor choice. It turns out that no matter what BAC had to pay, the best move was to simply pay it and move on.

At any rate, moving forward, BAC is now, finally, free to actually return to banking and stop simply litigating continuously and handing over shareholder money. At this point I'm not aware of any major suits outstanding against BAC that would cause an appreciable impact to earnings. The DoJ settlement was the last remaining piece of the puzzle from the crisis and it is now done, even if the price tag was ridiculous and arbitrary. Of course, market participants agreed and shares rallied huge yesterday on the news this nonsense is finally behind us.

I am a bit surprised that BAC released some of its legal reserves earlier this year when it knew that this settlement was hanging over its head; at the time I believed this meant BAC was over-reserved for the settlement and it turns out I was wrong. At any rate, we know that the pre-tax charge for the settlement above reserves as mentioned above so while that is perplexing to me, apparently it's no harm done in the eyes of the market.

Also consider the tremendous waste of resources that has been occurring for literally years since the crisis. Top management and teams of people have been working on simply settling lawsuits for so long that we have no idea how powerful the earning ability of this company really is. I have some guesses and I will share them but for now, know that the years of wasted effort spent doing something other than running the bank will now be plowed directly into creating value for shareholders, something that we haven't been able to say for a long time. This, perhaps, is the biggest positive that came out of the announcement for me.

I can't explain how happy I am, having been suffering with other BAC longs for so long, that the mortgage mess is behind us. The rally yesterday was amazing and I sincerely think there is more to come. Just having the overhang of this nightmare scenario gone is such a relief to investors that it seems nobody could buy quickly enough yesterday and since I'm long, I sure hope that continues. If you aren't long, take some advice from the venerable Regarded Solutions who, after being a BAC bear for so long, posted his very well-timed flip to a BAC long and is now making money along with the rest of us. Sunny days are ahead for BAC and I'm delighted that this unpleasantness is finally behind us.

Source: Bank Of America Wins By Losing