Bank Of America: Relief Rally Coming And Here's Why

| About: Bank of (BAC)
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Bank of America's litigation issues have kept the stock down for a long time.

The Wall Street Journal is reporting BAC is close to finishing talks with the Department of Justice over a potential settlement.

We'll discuss the implications for BAC shares given this news.

Well the day has finally come; Bank of America (NYSE:BAC) is looking to settle with the Department of Justice after the two sides have gone back and forth presumably since JPMorgan (NYSE:JPM) was in the hot seat months ago. Of course, that one ended up being $13 billion for JPM shareholders and everyone assumed the number would be the same for BAC. In fact, the WSJ is reporting the number will be "at least $12 billion" which, while still an enormous amount of money, isn't $13 billion or even worse, more than that. In this article, we'll take a quick look at the potential settlement and what it means for BAC shares.

I wrote a month ago about how BAC's litigation issues were potentially starting to clear up. In the article, I cited evidence from SEC filings that BAC had actually reduced its amount of litigation reserves, a move that many found puzzling given BAC's current status as a government piggy bank. However, it stands to reason that BAC must have had some idea of its exposure in order to be able to do that and I suspected at the time, and I believe it's confirmed now, that BAC knew this settlement was in the works and what the cost would be.

I'm never in favor of the government extorting money from private companies or citizens in order to make a point but what I am happy about is that this nonsense will finally be behind BAC and shareholders can concentrate on how it's operating as a financial conglomerate again as opposed to focusing on how big the next shake down will be. Recent commentary from BAC management has suggested that the DoJ settlement is the last "big one" left for BAC and that after this, litigation expenses should no longer be measured in billions each quarter.

Now, BAC can afford to pay out $13 billion; while that is an unfathomable amount of money for most of us, BAC has more than enough capital and reserves to pay it out. So while the number will come straight out of BAC's balance sheet, reducing the value of the corporation, I believe shares have already been trading down on this news. We have known for a very long time that BAC was going to have to settle with the DoJ; the only thing that was still up in the air was the amount. We received a clue when JPM settled for $13 billion and that set the stage for BAC's settlement. I think investors were worried we'd see $15 billion or more as BAC's Countrywide unit, while still independent, was really the poster child for bad mortgage practices. Thus, I think a settlement that comes in around $12 billion is really an upside surprise for shareholders.

The implication for shares is twofold; first, if BAC's settlement actually comes in around or under $13 billion, I think we'll see shares have a bit of a relief rally. As I said, I firmly believe investors were thinking it would be much worse than that so if the settlement comes in at or below what JPM had to fork over, we should see some relief buying. Second, it means that BAC's large litigation issues are truly behind it now. BAC will always have some kind of litigation going on and that is why they pay their enormous team of lawyers so much money to stick around. However, the litigation that comes down the pike should be so much smaller than what we're now accustomed to for the large banks as to be somewhat insignificant. Imagine if BAC settles some suit next year for $100 million; while that is also a huge amount of money, after the settlements we've seen, it's almost like that doesn't even matter.

The combination of the DoJ settlement finally coming through and the number coming in at a smaller-than-expected amount should drive shares higher in the short term due to a relief rally. The litigation issue has been hanging over BAC for a long time now but given the reduced legal reserves I mentioned a month ago and the DoJ settlement coming in, perhaps even lower than expected, investors should be relieved and send the stock higher.

Disclosure: I am long 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.