Winners And Losers Of Big Bank Lawsuits

Includes: BAC, C, GS, JPM, MS, WFC
by: Tom Dorsey

All of the large Wall Street financial institutions have been charged and fined by the federal government over the last 5 years stemming from the financial crisis of 2007-08. JPMorgan was just one of 17 financial institutions the FHFA sued in 2011. The suit accused them of selling Fannie and Freddie securities that "had different and more risky characteristics than the descriptions contained in the marketing and sales materials." The suit covered more than $200 billion in allegedly misrepresented securities. See a list of companies sued in the report above.

JPMorgan (NYSE: JPM) is the latest financial institution that has settled another case with the government. The settlement was for $5.1 billion for JPMorgan, Bear Stearns and Washington Mutual packaged securities. The agreement will pay Fannie Mae (OTCQB:FNMA) $1.26 billion and Freddie Mac (OTCQB:FMCC) $2.74 billion, with the rest in fines and legal fees. The deal also resolved a separate suit brought by the state of New York. Under a separate settlement announced by the FHFA on Friday, October 25, 2013, JPMorgan Chase Bank, NA will pay roughly $670 million to Fannie Mae and $480 million to Freddie Mac.

Unfortunately, the billions going to Fannie and Freddie will make their way back to the federal government's Treasury through the dividend sweep. And the billions designated for relief for struggling home owners will be distributed through some government program. The federal government will be the big winner here.

The news is not all bad, because JPMorgan earned $21 billion in profits in 2012 and they previously set $33 billion aside for fines, penalties and legal expenses. JPMorgan, like many of the other large banks, makes enough to pay these extravagant fines. All of the banks are attempting to settle, paying as little as possible (which is in the billions), and get this part of history behind them.

More on JPMorgan

Besides the above penalty, JPMorgan also settled a trading scandal for $100 million to the U.S. Commodity Futures Trading Commission, conceding "reckless" behavior led to the trading debacle that generated about $6 billion in losses. The CFTC said in a statement Wednesday that by selling a staggering volume of these swaps in a concentrated period, the bank "recklessly disregarded the fundamental precept on which market participants rely, that prices are established based on legitimate forces of supply and demand."

Last month, September 2013, JPMorgan agreed to pay about $920 million in penalties to U.S. and U.K. regulators to settle charges over the London Whale trades.

Through those fines, the bank acknowledged that it violated banking rules by not properly overseeing its trading operations. In legal language, regulators said that the bank engaged in "unsafe and unsound practices."

Bank of America (NYSE: BAC) and Wells Fargo (NYSE: WFC) have not settled with FHFA at this time. Bank of America, which acquired Countrywide and Merrill Lynch during the crisis era, could be on the hook for even more. BAC is facing claims from the FHFA over $57 billion worth of mortgage bonds. The Swiss company UBS (UBS) has already reached an $885 million settlement with the FHFA in connection with losses Fannie and Freddie sustained on over $6.4 billion worth of mortgage securities. The FHFA also settled for undisclosed sums earlier this year with Citigroup (NYSE:C) and General Electric (NYSE:GE).

Investors should view this as a process that the large financial institutions will have several quarters of profits, and fines, but at this point the majority of legal issues can be identified in lawsuits and expect to have enough money set aside to pay off any final suits, leading to a brighter future. The losers over the last 6 years have been the American taxpayers and the investors. Although the investors don't make the decisions, they bear the brunt of the losses in their investments.

Banks are in better shape now than before the financial meltdown and have improved their balance sheets and trimmed fat from their companies. All six of the large banks will make solid gains from business operations and earn profits during 2013. Some may reflect the settlements in the annual statements, but for the long term, they are strong performers.

JPMorgan's shares opened at $52.73 on Wednesday, October 30, 2013 and were up $0.18 in midday trading. The shares have returned 23% this year and trade for 8.8 times the consensus 2014 earnings estimate of $6.01 a share. That's one of the lowest forward price-to-earnings valuations for actively traded bank stocks. The consensus 2015 EPS estimate is $6.38. Based on a quarterly payout of 38 cents, the shares have a dividend yield of 2.88%.

It would be a mistake not to have some of these companies in your portfolio; however, timing your investments around the lawsuits would be the best. Further review of all the pending lawsuits will be in order prior to any investment. JPMorgan will need some time to recover from these settlements. The next 2 quarters should flush out the payouts and get the balance sheet and quarterly reports showing a profit again.

Bank of America and Wells Fargo are two banks I would recommend waiting on, to allow the settlements with FHFA. Citibank looks to be the first to settle and is now looking forward with less distractions. Investors will be winners with strong performances in the banking sector. The 6 big banks have displayed strong operating earnings, but the legal actions have drained billions of profits from the investors. As the legal suits pass, the investors shall be rewarded into the future.

Disclosure: I am long C, 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.