Bank of America Litigation Woes Costly
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Bank of America (NYSE: BAC) has a very good friend in Warren Buffett. A little over a year ago, with the financial sector on a deep spiral downward, Mr. Buffett announced that his corporation, Berkshire Hathaway (NYSE: BRK-A), would invest $5 billion in the ailing bank. In 2011, Bank of America's stock fell by more than 30% in August alone. There is little doubt that the company needed help. The move by Buffett, whom Forbes cites as the third wealthiest man in the world, was meant to bolster confidence in a corporation that has taken a thrashing on the market of late, with rumors swirling that it is capital poor and not likely to recover anytime soon.
The day the announcement was made, shares in Bank of America, as well as those of financial competitors Citigroup (NYSE: C) and Morgan Stanley (NASDAQ: MS) rose sharply, but then leveled out by the close of market. One of the world’s largest financial institutions, Bank of America has been besieged with legal problems and slow economic growth. The Wall Street Journal reported that the conglomerate announced at the end of September 2012 that it was settling for $2.4 billion in a lawsuit involving its purchase of Merrill Lynch four years ago.
This is not the first time that Warren Buffett has invested in troubled firms. Berkshire Hathaway gave Goldman Sachs (NYSE: GS) $5 billion and earned a sturdy 10% return for its largesse. It also threw $3 billion into General Electric (NYSE: GE), which also came with a 10% return. His return on preferred stock of Bank of America will earn him at least 6%; not a bad payout for his investment. Buffett has a knack for capitalizing on weak points, especially in underperforming financial entities.
What does Buffett’s investment in the Bank of America mean to common shareholders a year later? Buffett’s move clearly affected not just Bank of America, but was a small boost to the financial sector as a whole. Shares of Bank of America are on an upward trend this year, and the company is doing better than expected. More people are buying homes, so its mortgage business is looking better. Return on common stock will earn nothing like the 6% that Buffett has earned for his preferred shares, but surprisingly there will be a small return on shareholders’ investments.
Reaching a settlement on the litigation of the Merrill Lynch fiasco has worked to the company’s advantage on the market. Because of litigation risks and lost revenue as a result of them, investors have shied away from the company. As the legal woes become less of an issue, the stock looks more attractive to the common shareholder. But still, the company is finding the price of myriad lawsuits more costly as time goes by. It has put aside approximately $11.6 billion dollars to cover settlement and litigation expenses. That is a pretty hefty reserve and makes us wonder how much the company expects to have to pay out in further costs associated with lawsuits.
Analysts are mixed on Bank of America. Some call for a buy, some are neutral and others advise against investing in a company with so many legal issues. With the help of Warren Buffett, who obviously loves bank stocks, Bank of America has managed to keep its head above water and move in a somewhat positive direction. Shares closed slightly down last Friday at $9.12. The week on the whole was something of a roller coaster ride for the company, with stock closing down 2.15%.
CEO Brian Moynihan announced this week that the company plans to cut 30,000 jobs in an effort to bolster revenues that remain flat. It is still dealing with mortgage issues from Countrywide and the Merrill Lynch settlement, to name just two of the legal concerns plaguing the business. With all of its current problems it is not easy to decide if this company is worth adding to a portfolio, but the price of the stock is attractive. It’s worth doing a little research to see if Bank of America is finally trending upward, but at this point it is doubtful. Until the bank shows a stronger performance, this does not appear to be a viable risk.
muhammadbazil owns shares of General Electric Company. The Motley Fool owns shares of Bank of America, Berkshire Hathaway, Citigroup Inc , and General Electric Company. Motley Fool newsletter services recommend Berkshire Hathaway and Goldman Sachs Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.