The Single Biggest Threat to Bank of America Today

This is the first in a series of five articles covering Bank of America's legal problems since the financial crisis. Links to the rest of the series are at the bottom of this article.

If Bank of America (NYSE: BAC  ) faced death by supernova during the financial crisis, in the years since, it's been battling death by a thousand cuts. Though we're now five years past the darkest days of the downturn, the executives at B of A remain profoundly ensconced in it thanks to a seemingly endless barrage of lawsuits stemming from the ill-fated acquisition of Countrywide Financial in 2008.

Although this may sound like hyperbole, the manner in which these lawsuits play out will dictate not only when B of A fully emerges from the proverbial fog of war, but even if it completely emerges at all. Tens of billions of dollars in legal liability from these suits could still bring the lender to its knees.

What follows is the first of five articles providing an in-depth analysis of not only B of A's legal victories, which are many, but more importantly, the threats that lie ahead for the nation's second largest lender by assets.

Appreciating the scale of B of A's legal liabilities
B of A's purchase of Countrywide will go down in history as one of the worst, if not the worst, corporate acquisitions of all time. In the four years leading up to the financial crisis, Countrywide underwrote a staggering $1.562 trillion in residential mortgages. Those mortgages were then sold to government-sponsored agencies Fannie Mae or Freddie Mac or packaged into mortgage-backed securities and peddled to institutional investors like university endowments, public pension funds, and insurance companies. A full $301 billion of these loans have since either gone into default or are severely delinquent -- that is, more than 180 days past due -- and investors are now looking to B of A to make them whole.

Given the scale and multitude of legal claims brought against B of A, it's understandably hard to appreciate the progress the bank has made versus the challenges that remain. To this end, I've found it helpful to break the analysis down into three different buckets:

  1. Lawsuits and settlements related to the servicing of mortgages. 
  2. Settlements related to the sale of whole mortgages to government-sponsored agencies Fannie Mae and Freddie Mac. 
  3. Lawsuits related to the sale of mortgage-backed securities to institutional investors. 

You can see this breakdown in the following infographic -- the green houses represent settled claims, and the red houses show estimates of liability remaining.

Sources: Court documents, media reports, and Bank of America's annual and quarterly filings.

In terms of progress, the best news so far has come from the mortgage-servicing issues (the first bucket). In February of last year, the bank joined four other mortgage servicers -- JPMorgan Chase  (NYSE: JPM  ) , Citigroup  (NYSE: C  ) , Wells Fargo  (NYSE: WFC  ) , and Ally Financial -- in a landmark settlement with the U.S. Justice Department and 49 state attorneys general. The deal called for a total of $25 billion in cash and other relief to borrowers, with B of A's share weighing in at a whopping $11.82 billion.

Then, in January of this year, B of A joined with nine other mortgage servicers to settle similar claims brought by the Federal Reserve and the Office of the Comptroller of the Currency. Taken together, while expensive, these agreements effectively put the mortgage-servicing component of B of A's liability to rest.

B of A has also addressed the lion's share of its liability stemming from the sale of mortgages to Fannie Mae and Freddie Mac (the second bucket). Between 2004 and 2008, Countrywide sold a total of $846 billion in mortgages, or 54% of its aggregate origination volume, to these institutions. By the end of last September, a full $71 billion of the mortgages were in default, and $40 billion were severely delinquent.

In two settlements, one at the beginning of 2011 and the other at the beginning of this year, B of A paid a total of $10.08 billion (including cash and non-cash relief) to extinguish "substantially all" unresolved claims, as well as any future claims associated with loans sold to the government-sponsored enterprises. That settlement amount equates to roughly $0.09 on every dollar of the loans that were either in default or severely delinquent.

The trickiest bucket of all
The only bucket remaining, then, is the one related to Countrywide's sale of mortgage-backed securities to institutional investors. The problem is that this slice of the liability pie -- while representing only 46% of Countrywide's mortgage origination volume from 2004 to 2008 -- accounts for an inordinate share of B of A's total liability. This is because the mortgages packaged into securities were the worst of the worst, both in terms of how they've performed and the adequacy of the underlying collateral.

As noted above, of the $846 billion in mortgages sold to the GSEs, a total of $111 billion, or 13%, have either defaulted or are severely delinquent. By comparison, of the $716 billion in mortgages sold to private investors, $190 billion, or 26.5%, are similarly situated. In addition, most loans sold to the GSEs are secured by first liens, whereas many of the mortgages sold to private investors are secured by second and/or third liens.

While the amount B of A will end up owing to purchasers of Countrywide's MBSes remains a mystery, we know at least two things. First, it'll probably be a generous amount. And second, whatever the amount, it'll be a function of three different categories of cases making their way through the courts:

  • BoNY breach-of-contract: A proceeding in New York in which B of A is seeking judicial approval of an $8.5 billion breach-of-contract settlement between Countrywide, 22 institutional investors, and Bank of New York Mellon  (NYSE: BNY  ) acting in its capacity as the trustee for $424 billion worth of MBSes. 
  • Insurers breach-of-contract: A handful of cases -- likewise in NY -- that concern breach-of-contract actions brought by bond insurers like MBIA  (NYSE: MBI  ) that insured Countrywide's mortgage-backed securities against default. 
  • Securities fraud: More than 20 cases in a federal court in California that address claims of securities fraud against Countrywide and an assortment of other Wall Street banks related to the sale of MBSes.

So, where does B of A stand?
If you're an investor in B of A, it probably seems like the bank will never be done paying for its ill-fated decision five years ago to purchase Countrywide. But what I hope I've demonstrated here is that the end is indeed in sight. It's just a ways off.

The bank has already put tens of billions of dollars in liability behind it with the GSE and servicing related global settlements. And by quarantining the lion's share of remaining lawsuits into only two courts -- the New York court overseeing the BNY Mellon settlement and claims by bond insurers, and the federal court in California presiding over the securities fraud charges -- B of A's legal team has positioned the bank to reach global settlements with the remaining litigants.

This isn't to say that things couldn't go awry, because they most certainly could. But the chances of that are decreasing with time.

While this may be the most pressing issue for Bank of America investors to consider, the big picture is much bigger than just the bank's legal issues. To dig in further on the banking giant, I invite you to check out our in-depth company report on Bank of America. The report details Bank of America's prospects, including three reasons to buy and three reasons to sell. Just click here to get access.

Continue reading this series:


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Comments from our Foolish Readers

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  • Report this Comment On February 15, 2013, at 3:14 PM, czbill12 wrote:

    Death by 1000 cuts or Supernova...with their policies relating to individuals, businesses, etc I for one will be cheering on the sidelines when this happens. I hate it for the employees, but most banking friends I know have long ditched this convoluted company.

  • Report this Comment On February 15, 2013, at 5:14 PM, nofoolingforme wrote:

    Yeah. That Warren Buffet! He keeps making one stupid move after another like investing in B of A. He should listen to the brilliant author of this piece- if he had any business smarts at all!

  • Report this Comment On February 15, 2013, at 5:18 PM, dustbusterz wrote:

    in this story , you say you wrote about 3 reasons to invest inBank of America, and 3 reasons not to invest . But as I see it, there is never ever a reason to Invest with a crooked Company. They have shown us they cannot be trusted with our money or any ones money,so we should show them we only invest with companies who can be and are trustworthy. they nearly cause to collapse of Not Just America, but so many other Countries, so there is no reason to put our money in their bank or their stocks.

  • Report this Comment On February 15, 2013, at 6:04 PM, multi007 wrote:

    @dustbusterz - you only need 1 reason to invest, to make money. Period. That is why casino's, liquor, cigarette companies (aka the "sin" stocks) do well in a recession (although not guaranteed).

    Im long 1000 call options $10 strike Jan 14 ex and 1000 call options $15 strike, Jan 15 exp.

    Crooked or not, I'm looking for profit. This is a long company. Little headwinds they haven't planned for.

  • Report this Comment On February 15, 2013, at 6:07 PM, 102971 wrote:

    If I could buy at the price WB did I would but frankly I think in the long run he'll still lose money. BOFA is the worst managed bank in the world and I can't see it surviving.

  • Report this Comment On February 15, 2013, at 10:25 PM, CathrynMataga wrote:

    But TBTF -- so they have infinite 'get out of jail free cards.' The courts will back off. No one can do anything however bad the findings because that might 'hurt the economy.'

  • Report this Comment On February 15, 2013, at 11:25 PM, Bkeepr100 wrote:

    Does not help their company when they start denying credit and/or loans to gun manufacturers recently. They don't support the second amendment rights or jobs anymore...

    Why should I support their business either??

    All the big banks should have been allowed to fail during the crisis not bailed out by the government.

  • Report this Comment On February 15, 2013, at 11:26 PM, whereaminow wrote:

    Please..

    You write this article as though Bank of America has costs that need to be balanced against profits. How much does it cost to have money handed to you from the Federal Reserve?

    BoA will make ridiculous, hand over fist profits. It trades low right now because a few people actually think Elizabeth Warren isn't a complete retard, and they're afraid she'll impact BoA's "business". They will soon find out the truth.

    And then BoA will blow it all again when this coming housing bubble (and stock bubble [check it out! All time highs during a weak economy! Rents and housing prices skyrocketing! Strap on or strap in, folks!]) crashes as all funny money bubbles are destined to do.

    And then they'll rob the tax payers again, next time for even more fake cash.

    Let's just hope the dopey journalists at Motley Fool wake up this time and oppose the next bailout, unlike the way your staff completely disgraced itself in 2008. It's coming. Give it time.

    David in Liberty

  • Report this Comment On February 16, 2013, at 12:25 PM, beastofbodmin wrote:

    From 7 to 12 since July ain't a bad return.

    Didn't mention the effect of the Japanese printing presses that will start to roll in a few months. That's usually good for banks, even corrupt TBTF ones.

    AFAIR certain NY courts are in the pockets of the banks, no? Including proof of altering court transcripts. And when is the last time a bank got a criminal record?

  • Report this Comment On February 17, 2013, at 1:48 AM, CathrynMataga wrote:

    Another thing that puts this in perspective is the HSBC settlement. These guys laundered drug money, and allegedly even dealt with Islamic terrorist groups, and yet, they just pay a little fine. Admittedly Countrywide was the ultimate money black hole of death, but, still, appreciate that the worst of Bank of America's problems are merely criminal fraud -- I haven't read anything accusing them of crimes on the level of what happened at HSBC. Those guys aren't even American and they got off with a wrist slap -- BofA should have nothing to fear from the Justice system.

  • Report this Comment On February 17, 2013, at 3:09 PM, crouseii wrote:

    OMG BOA STORY ALMOST SOUNDS MORE UNAMERICAN THAN OUR LEADER MOSLIM ZAR LEADING THE USA INTO SOCILISOME--PS UNDERSTAND A BILL HAS BEEN SUMMITED TO ADD A 3RD TERM IN OFFICE OF THE PRESITENT OF THE USA UGL THANK COD AM 80 YEARS OLD BUY SORRY 4 MY CHILDREN AND GRAND CHILDREN'S FUTURE

  • Report this Comment On February 18, 2013, at 8:00 AM, keninden wrote:

    Its hard to feel sympathy for BofA, but as I recall they took over Countrywide at the behest of the federal government, at time when financial institutions were dropping like flies. Barney Frank recently confirmed this. The white knight became responsible for the crimes of the rescued.

    Related: did BofA have no idea they they would assume Countrywide's liabilities? If this a complete surprise to their legal staff?

    How our understandings have changed since early 2008!

  • Report this Comment On February 18, 2013, at 8:48 AM, POdTexas wrote:

    They are all crooks and knew of Countrywide's tactics back in 1998. My mom's mortgage was with Countrywide and she unexpectedly died, but was current on her mortgage. It took me several months to come up with the past due payments, which Country Wide would not accept; they wanted the full amount of the mortgage. Never mind that Texas has a 3 yr. statute to reconcile the debts of an estate, it was ignored within a relatively short period of time and no one would listen to reason. They foreclosed without notice to the heirs, cashed in the mortgage insurance and resold her property at almost 66% profit. We did not get a nickel and Greg Abbott's office did nothing even though I spoke to his EEOC lackey in person. Fraud is fraud and it ran the whole gamut, so how is Bank of America responsible when they all knew these practices where going on for years starting with the probate judge and through numerous attorneys. All of this money will be used to line the pockets of everybody else except the consumer that got the shaft.

  • Report this Comment On February 18, 2013, at 10:33 AM, StopPrintinMoney wrote:
  • Report this Comment On February 18, 2013, at 10:35 AM, StopPrintinMoney wrote:
  • Report this Comment On February 18, 2013, at 10:51 AM, hiddenflem wrote:

    I was going to say that the biggest threat was their horrible customer service but your take is good too.

  • Report this Comment On February 18, 2013, at 11:43 AM, lachylan wrote:

    John,

    Thanks a lot for taking on the task of trying to chart BAC's legal woes - you've done it better than any commentator I've come across in the last three years of reading everything I could about this company. One thing I've wondered about but have never seen addressed ... is there ever a point (and, as above, I'm well aware of all the destruction its wrought) where the Countrywide acquisition becomes a positive for the company?

  • Report this Comment On February 18, 2013, at 1:09 PM, JohnMaxfield37 wrote:

    lachylan,

    I appreciate the comment.

    Unlike Merrill Lynch, which I think will ultimately turn into a net gain for B of A (though the Merrill acquisition was the primary cause all the dilution in '09), it's my opinion that Countrywide never will.

    If you look at what B of A's done over the past couple years, it's basically cleaning its hands of the Countrywide operations. It dropped correspondent lending, is aggressively selling mortgage servicing rights, and has scaled back its mortgage lending operations to retail only -- that is, principally customers that already had/have a relationship with B of A.

    As a result, unless you're one of B of A's competitors (namely, Wells Fargo), I don't see anything good coming from the Countrywide deal either now or in the future.

    John

  • Report this Comment On February 18, 2013, at 5:23 PM, Grahdodd wrote:

    Outstanding piece. Thanks for the nice recap.

  • Report this Comment On February 18, 2013, at 5:49 PM, rocketman67 wrote:

    Gee I would have thought it would have been the IDIOTS whom are running the show right now at BOA!

  • Report this Comment On February 18, 2013, at 7:37 PM, onewhoknows4sure wrote:

    IMO the author is overly optimistic about the potential losses from the suits.

  • Report this Comment On February 18, 2013, at 8:18 PM, poach wrote:

    Thanks John

    Good article!

  • Report this Comment On February 18, 2013, at 11:41 PM, topbeancounter wrote:

    Nice article but most of your facts are nonsense. B of A took over the entire servicing end of Countrywide, that was turning out a huge legitimate profit every month, and replaced it with B of A folks, some of which had no clue what they were doing. One top person came from the CREDIT CARD division. What could possibly go wrong?

    There were problems coming up at Countrywide, but had it been run honestly from the top, I think they could have survived on their own.

    B of A's own incompetence then took over. Warren Buffet smelled blood, since the week after the current liar, I mean leader, of B of A publicly stated they needed no capital, somehow Warren's folks figured out the truth, offered $5 billion in 10% dividend paying preferred, and the option to purchase a gazillion shares at about $7.23 I think. Now whose stupid? Brilliant move by Mr. Buffet.

    What B of A continues to not mention is how many of their own loans are crap. They are presently lightening their load out to others that have a better understanding of the business and can make money by doing the right thing. It's actually pretty funny when you look at it.

    Don't get me wrong, I made quite a few bucks buying it in the $3 to $5 range and selling it later. I knew the government couldn't let it fail like they did with Lehman Bros. But at some point, someone that writes these stories for publication needs to get their facts straight. So far, none have.

  • Report this Comment On February 18, 2013, at 11:55 PM, tjhandcfm wrote:

    Bank of America should sue Angelo Mazillo, founder of Countrywide, for every dime he has before somebody caps the crook.

  • Report this Comment On February 19, 2013, at 8:57 AM, LHowe58 wrote:

    I had recently taken a peek at the financial disclosures of some of my most (un) favorite members of Congress. Nancy Pelosi is especially heavy with BoA stock. Since Congress is notororious (but not held accountable) for passing legislation to line their pockets, I'd think that Warren Buffet is no fool for buying BoA stock.

  • Report this Comment On February 19, 2013, at 9:52 AM, topbeancounter wrote:

    Hey TJ, I'm sure they would have sued Mazillo if they could, but he got them to underwrite all of his legal costs and fines. I suppose if they could ever drag him back from his Italian home, with both hot and cold running young women, they might try.

    Now who is the stupid one again?

    Bet that isn't in the other four sections of this story either.

  • Report this Comment On February 19, 2013, at 4:04 PM, mikecart1 wrote:

    I bought a ton of BAC when it was under $4/share and everyone said it was doomed. They said it was still doomed when it doubled.

    You can't bet against the best. That is me, not Buffet talking. I won't even think about selling any of my holding until BAC is at least $20/share. I am in no rush. I got decades to wait.

    :D

  • Report this Comment On March 28, 2013, at 6:15 PM, sluggo47 wrote:

    This question remains unanswered. Why in H##L did BAC buy Countrywide? Can it ever produce a profit? If there was due diligence involved it is not apparent.

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