Bank of America, Legal Mess At The Moment

Ron is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Just two weeks back, the United States' third largest bank by assets, Citigroup (NYSE: C) got sued by Sealink Funding Ltd for losses related to $513 million worth of investment in residential mortgage-backed securities.

One day back, Morgan Stanley (NYSE: MS) was sued for misrepresenting and omitting vital information on the underwriting procedures for investment in $694 million worth of mortgage-backed securities.

Today, there is legal news about another US bank getting sued yet again. Bank of America Corp. (NYSE: BAC), the second largest U.S. bank by assets, got sued by CIFG Assurance North America Inc. for deceit and breach of contract over insurance policies related to residential mortgage-backed securities.

Here's an excerpt from a BusinessWeek article:

"Bank of America had these securities in its inventory because it had been unable to sell them when it served as underwriter on the original RMBS offerings," CIFG said in the lawsuit. "Bank of America knew of the poor quality of the mortgage loans, and knew the original unsold RMBS were a ticking time bomb on the bank's books."

The bank, unable to sell the securities in pieces, then "hatched a new plan of financial engineering," repackaged the bonds, and induced New York-based CIFG to provide more than $150 million in insurance to make them marketable to investors, the insurer said in the suit.

As per the lawsuit, CFIG might have to pay around $170 million in claims on insurance policies issued on these low-grade RMBS. Needless to say, if judged favorably toward CFIG, this might turn out to be an expense worth $170 million (or more) in the coming quarterly income statement of this year.

It must still be remembered that this is not the first time CFIG filed any lawsuit on any bank or mortgage firm. CFIG was one of the interveners in the $8.5 billion settlement between investors and Morgan Stanley owned Countrywide. It also filed a lawsuit worth $277 million against Greenpoint Mortgage Funding Inc. last month and $275 million lawsuit against Goldman Sachs in 2011, although Goldman Sachs (NYSE: GS) successfully got part of the lawsuit dismissed by Justice O. Peter Sherwood.

You cannot ignore legal expenses when it keeps popping up in each of the financial statements. It must be remembered that B of A already hinted the legal costs as high as $2.8 billion above what has already been set aside. This is excluding the class-action settlement related to the Merrill Lynch takeover in 2009.

Apart from the legal expenses, what about the repurchase claims?

As a matter of fact, Countrywide sold almost $1 trillion in mortgages and/or mortgage backed securities (MBS) to government agencies such as Fannie Mae and Freddie Mac. Last quarter, it was expected that around $132 billion among that $1 trillion would pop up as severely-delinquent repurchase claims very soon. And it seems it hasn't been over yet. BofA's Chief Financial Officer, Bruce Thompson expects the repurchase claims from private investors to grow in the coming few quarters.

Even if B of A cuts out the ones on which at least 25 payments have been made, it still has to incur over $15 billion loss. And that only happens if Fannie Mae accepts to that "25-payments" clause.

Surprisingly, all these happens just when Chris Mutascio, managing director of Stifel Nicolaus, said earnings will grow 30% next year vs. less than 5% for the rest of the big banks, which have "bled" loan loss reserves dry and "have no material expense reductions on the horizon." The bank's faster-than-expected rebuild of capital ratios should allow a dividend increase early next year.

As per my knowledge, even ISI group has rated BofA as a Buy.

If you ask me, the second largest US bank, with $2.2 trillion in assets and $1 trillion in deposits, is just too big to fail but with the declining deposits and loan balances, and string of legal expenses and repurchase claims, it might take some to see some serious rebound in the income statement and thus, in the stock price.


Fool blogger Ron C does not own shares in any of the companies mentioned in this entry and does not wish to open any position in the next 72 hours.

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