There are a lot of companies I like, and I know that sometimes that means I'm not as rational about them as I should be. Sometimes, earnings aren't as high as they really should be, and I say, "Well, they're focusing on growing market share" or "One little bump in an otherwise smooth road." Investors do this sort of thing because we get hooked on a company's story, or product, or turnaround potential. In general, it's a confirmation bias problem, where we only see the good things about a company and gloss over the dark underbelly.
If that's the case, then investors must be having an extra-marital affair with Bank of America (NYSE: BAC ) . Yesterday, the bank agreed to more than $11 billion in fines and fees for mortgages that went kaput during the crisis. The fine is broken into two pieces, a $3.6 billion payout to Fannie Mae, and a $6.8 billion mortgage buyback . But it looks like Bank of America investors got some other paper on their doorsteps, because the stock only fell a measly 0.5%. What's going on here?
How Bank of America screwed up
It's safe to say that when a company has $11 billion levied against it, it probably did something wrong -- probably a few things, to be honest. Bank of America isn't actually the originator of the problem, in this case. Instead, the charges come from Countrywide, which Bank of America purchased in 2008. Fannie Mae alleged that Countrywide sold it a whole pile of mortgages at a lower quality than it presented. In effect, it lied about the risk that Fannie Mae was going to have to take on .
For years now, Bank of America has been trying to resolve all of the little nightmares that Countrywide brought with it. This newest round of charges wasn't unexpected, and the bank will only have to take about $2.7 billion off of its fourth-quarter income to cover itself . That should put the bank at close to $0 for the quarter, and leave annual income near its third-quarter year-to-date position at $3.5 billion . Not only will the bank suffer this time around, it's the second time this year that it's seen income disappear. Third-quarter income fell to $340 million after fines were accounted for. So why do people love this bank?
Why investors stick with Bank of America
Bank of America is not without its strengths, especially when it comes to mortgages. First and foremost, it services close to six million mortgages, although it's trying to reduce that number . Those servicing fees provide a nice stream of cash. But the bank is spending a lot of resources to get that cash since delinquent mortgages cost more to service. Yesterday had a silver lining for investors as the bank offloaded 2 million mortgages, 232,000 of which were delinquent -- that's great news for the company.
Second, all of the big banks just got a shot in the arm today with the relaxed standard of what counts as capital for Basel III requirements. Whereas the liquidity requirements used to only allow for things like actual cash and government issued bonds, now banks can count such never-fail investments as stocks and mortgage-backed securities . Bank of America stacks up well against its peers with a 9% capital ratio, which is better than JPMorgan (NYSE: JPM ) at 8.4% or Wells Fargo (NYSE: WFC ) at 8% .
Finally -- and this is where I walk away from the table -- Bank of America's legal burden is constantly being clarified in ways that competitors' positions aren't. So the fact that the bank just settled for over $11 billion is seen as a good thing, since it means now we know, and knowing is half the battle. Other banks are still wondering when the hammer is going to come down, as it did for Barclays (NYSE: BCS ) and HSBC (NYSE: HSBC ) last year. Both banks were caught up legal issues, paying out $450 for LIBOR rigging and $1.9 billion for money laundering, respectively.
The bottom line
Let's be frank: Bank of America just got hit with a huge settlement, which does clarify things, but isn't "good." In October, the bank was subpoenaed over potential LIBOR rigging . While this may be the end of one lawsuit, it's by no means the end of all legal problems. Bank of America is a risky investment, and I think it's a bad investment. The bank isn't interested in doing what's right, it's interested in playing the game. That means that as the games rules change, as Basel is updated, as the regulatory environment changes... Bank of America will always be on the back foot.
Yes, that same charge could be leveled at all the big banks, and yes, I think they're all too risky to invest in. That may mean losing out on some gains, but it also means getting a good night's sleep.
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