The Light is Dim for This Bank
Kathleen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Some of the leading banks in the U.S. have been greatly concerned about litigations that stem from several allegations including LIBOR manipulation and old mortgage-related problems. Mortgage-related lawsuits have been recently initiated by the offices of the U.S. attorney general and the attorney general of New York State against Wells Fargo (NYSE: WFC) and JPMorgan (NYSE: JPM). These lawsuits have pulled both banks to the courtroom where they have been forced to defend themselves on issues involving housing loans and securities. On Wednesday, October 24, federal prosecutors also slammed a $1 billion mortgage-related lawsuit against Bank of America (NYSE: BAC) on the allegation that its subsidiary, Countrywide Financial, used false mortgage information to defraud Freddie Mac and Fannie Mae. Fannie and Freddie are government-sponsored mortgage companies. As far as investments go, the light at the end of the tunnel is very dim for the financial institutions involved in these lawsuits.
The Purpose of the Federal Lawsuit
The federal prosecutors’ target was to recover part of the losses sustained by Fannie and Freddie due to defaulted housing loans. Allegedly, the home loans packaged by Countrywide are fraudulent. The suit was filed under the False Claims Act. This suit could enable the Justice Department to claim up to three times the damages suffered.
Turning the Corner Despite a Toxic Asset
The feds claim that this financial problem started in 2007 and extended to 2009 via Countrywide’s mortgage program called The Hustle. This program eliminated background checks on the quality of home loan applications. Bank of America is being sued in part for an alleged breach that Countrywide committed before it was acquired by BAC in 2008. Countrywide Financial has been a toxic asset for BAC since it was acquired. Although it doesn’t appear the problem will go away soon, Brian Moynihan’s led team has shown it has the capacity to manage difficult situations. The bank has turned the corner on capital adequacy from some of its worse levels to a Basel 3 Tier 1 capital level of 8.97%. Compared to JPMorgan’s 8.4%, Citigroup’s 8.6%, and Wells Fargo’s 8.02% capital levels, BAC is currently one of the best capitalized banks among the U.S. top banks.
How the Lawsuit Could Affect Investors
If this lawsuit succeeds, it will add to BAC’s list of agreed settlements and pending judgment debts that, not including rising legal costs, currently run into the billions of dollars. In early 2011 BAC agreed to settle Fannie and Freddie with over $3 billion in mortgage-related repurchase claims. In June 2011, BAC agreed to pay an $8.5 billion settlement to 22 institutional investors. This settlement included Blackrock and American International Group (NYSE: AIG) due to warranty claims on mortgage securities. AIG proceeded with a $10 billion suit in its bid to claim more damages from Bank of America. Though the current suit won’t create the worst scenario for the institution, if it succeeds, it could make savvy investors nervous enough to dump the stock. This could cause the share price to become significantly lower.
The Outlook for Bank of America
BAC’s recent third quarter results show a net profit of $340 million from a total revenue of $20.7 billion. This is down from a net profit of $6.7 billion over $28.6 billion in revenues made during the corresponding period in 2011. BAC lost $33 million after it paid preferred dividends and ended up with $0.00 earnings per share against the $0.07 earnings per share that analysts were expecting the bank to declare.
Despite the news of the rebound of the housing sector, profitability is not in sight for BAC in the foreseeable quarters unless management has a quick and miraculous cure for clearing up the mortgage mess that is still weighing heavily on the mind of investors. As of the last quarter, mortgage-related repurchased claims have gone up to $25.5 billion. There is also no sign that these claims will stop anytime soon.
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