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A recent Bloomberg article on Bank of America (NYSE:BAC) raises the possibility that Bank of America could allow its Countrywide subsidiary to file for bankruptcy in order to get out of the mortgage liabilities that have been plaguing the bank. The article states: "Bank of America Corp. (BAC), the lender burdened by its Countrywide Financial Corp. takeover, would consider putting the unit into bankruptcy if litigation losses threaten to cripple the parent, said four people with knowledge of the firm’s strategy. The option of seeking court protection exists because the Charlotte, North Carolina-based bank maintained a separate legal identity for the subprime lender after the 2008 acquisition, said the people, who declined to be identified because the plans are private." Read the entire article here.

A number of lawsuits have been filed against Countrywide by plaintiffs who allege they were sold bad mortgages. This overhang of litigation is one of the many factors causing downward pressure for BofA shares. I am surprised that the bank has not been more vocal about the Countrywide bankruptcy option, because I believe the bank could use it to get some loss sharing agreements on the mortgages from the U.S. Government since a bankruptcy filing by Countrywide could be very harmful to the economy and a bankruptcy filing would ultimately cost the taxpayer and the government money. I believe Ken Lewis was mistaken in not negotiating a loss sharing agreement with the government when buying Countrywide in the first place. Furthermore, the possibility of a bankruptcy filing should be used to keep plaintiffs from demanding excessive amounts in any settlement over these securities. The article goes on to state:

"The threat of a Countrywide bankruptcy is a 'nuclear' option that Chief Executive Officer Brian T. Moynihan could use as leverage against plaintiffs seeking refunds on bad mortgages, said analyst Mike Mayo of Credit Agricole Securities USA. Moynihan has booked at least $30 billion of costs for faulty home loans, most sold by Countrywide during the housing boom, and analysts estimate the total could double in coming years."

I believe that just like a stock trade that has gone bad, BofA should immediately look to cut losses from the Countrywide purchase and let mortgage plaintiffs and the U.S. Government know that Countrywide will be filing bankruptcy by the end of 2011 if loss sharing agreements and mortgage settlements are not completed. This solution is far better than allowing the bank to remain under a cloud of litigation and uncertainties for many years. BofA shares would likely see significant upside if the company started to act on this option rather than continue to pay for losses and remain in litigation.

Here are some key points for BAC:

  • Current share price: $7.23
  • The 52 week range is $6.31 to $15.31
  • Earnings estimates for 2011: loss of 30 cents per share
  • Earnings estimates for 2012: profit of $1.23 per share
  • PE Ratio: about 5.5 times 2012 earnings
  • Annual dividend: 4 cents per share which yields .5%

Data is sourced from Yahoo Finance.

Disclosure: I am long BAC.

Source: A Countrywide Bankruptcy Could Significantly Boost BofA Shares