What An $8.5-billion Settlement Would Mean for Bank of America

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Bank of America (NYSE: BAC) lost the trust of millions after its Countrywide Financial subsidiary lent money based on underwritten mortgages, but the bank looks ready to earn back investors.

BofA was eventually blamed for much of the sub-prime mortgage crises and was sold off in spades. Now, the company is looking to win back investors after it completes a mandatory settlement. The $8.5-billion settlement would address issues the bank had with investors who owned bonds issued by Countrywide. Paying the investors and leaving this issue behind will mean the end of the grunt work associated with the financial crises that Bank of America was in the thick of, and which caused the share price to drop from around $40 to $5. Paying the investors will also show those who were doing business with the bank -- either as customers or as investors -- that the firm has paid for its mistake.

The deal might not go through 

But many are calling the $8.5-billion sum pennies on the dollar. Insurance titan AIG asserted the deal is full of conflicts of interest between those who are involved in the agreement, and the penalty isn't nearly enough. The agreement involves 22 institutional investors, including Bank of New York Mellon, Blackrock, Metlife and Pimco.

However, Bank of America has already suffered from around $50 billion in charges that were connected to underwriting mortgages and marketing them to investors in the years leading up to the recession. That was done at arm's length through Countrywide.

What would the settlement mean?

If approved, the settlement wouldn't cost the bank a lot of money, but it would put an end to most of the cold shoulder the bank is receiving from investors. In turn, shares of JPMorgan Chase (NYSE: JPM) could drop and Citigroup (NYSE: C) will have to work hard to keep investors.

Why JPMorgan is Likely to Fall

JPMorgan has made a slew of acquisitions during and since the recession, which has shown the considerable strength of the firm. I credit much of the company's rising price to those acquisitions, as investors noted the bank's buying power and got in on what they perceive to be a good thing. That could very well be true, but with Bank of America's price well below its pre-recession high, many investors might do what they do best and "buy low, sell high." Furthermore, many of the takeover acquisitions JPMorgan has made have resulted in lawsuits because many of the deals were subprime-related. At the time, JPMorgan was doing business with now infamous companies Bear Sterns, Long Beach, and Washington Mutual. JPMorgan could lose billions for repurchasing residential mortgage-backed securities (RMBS).

JPMorgan is also facing a variety of risk factors, such as market risk, regulatory risk, liquidity risk, legal risk, credit risk and operational risk. The company even pointed that out in a 12,000-word 10-K. And at least eight federal agencies, federal prosecutors, and the FBI are reportedly investigating the firm, as the New York Times pointed out. Avoid this bank!

Why Citigroup is Less Likely to Lose Out

Citigroup may also lose out as investors switch back to Bank of America. However, it doesn't look primed to dive as far as JPMorgan. The company is also well off its pre-recession price of about $550. Citigroup has also recently settled a lawsuit related to selling hundreds of millions of dollars worth of mortgage-backed securities. The May settlement wasn't disclosed to the public, but the company was being sued by Allstate over more than $200 million of securities purchased from Citigroup. That lawsuit is peanuts compared to the potential Bank of America deal that could cause investors in banks to lean towards BofA. 

In looking at the complete picture, Citigroup still hasn't cleaned up much of the mess left by the financial crises. While BofA is making massive payments to address issues, Citigroup's balance sheet is still riddled with flaws. The firm has nearly $150 billion in bad loans, which will drag down profits. Furthermore, the ongoing lawsuits aren't being settled fast enough, and the company still faces a major hindrance due to a lawsuit from the Federal Housing Finance Agency.

What now?

As a long-term investor, I am ready to ride out the sharp price fluctuations that are likely to hit BofA in the next year, as it faces much of the rises and falls of positive and negative economic news. This company is rapidly healing from the recession and is just about in shape to hit a home run, and that trend has already started. JPMorgan and, to a lesser extent, Citigroup, are about to get crushed. Sell those two companies and buy BofA, and then keep up to date with earnings and settlement agreements, as these will likely indicate a chance to put more money into this company.

Bank of America’s stock doubled in 2012. Is there more yet to come? With significant challenges still ahead, it’s critical to have a solid understanding of this megabank before adding it to your portfolio. In The Motley Fool’s premium research report on B of A, analysts Anand Chokkavelu, CFA, and Matt Koppenheffer, Financials bureau chief, lift the veil on the bank's operations, including detailing three reasons to buy and three reasons to sell. Click here now to claim your copy.

Phillip Woolgar has a position in Bank of America. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America, Citigroup Inc , and JPMorgan Chase & Co.. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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