Bank of America Corp’s Latest 11-Figure Settlement and Why It Might Be a Good Thing

Bank of America is facing a possible settlement of more than $12 billion with the Justice Department, and can't wait to pay it.

Jun 9, 2014 at 11:00AM

According to the Wall Street Journal, Bank of America (NYSE:BAC) could end up paying more than $12 billion to finally settle their pending litigation with the U.S. Justice Department.

This may sound like a ton of money, and it is, but it's really not as bad for Bank of America as it sounds. In fact, the company could even be looking forward to the day they'll get to write that big check.

Bac

Why such a big settlement?
Just like most of the settlements before it, this one stems from poor handling of bad mortgages. Specifically, the Justice Department says mortgage-backed securities sold by the bank were of much worse quality than they led investors to believe.

At least $5 billion of the expected settlement is expected to be earmarked for consumer relief, and will go toward helping struggling homeowners reduce the principal and/or monthly payment amounts of unaffordable mortgages.

It's better than it could be
The first reason the $12 billion figure could be good news for the bank is because it's less than the Justice Department was originally seeking.

It was reported the original figure was $20 billion, which included the $6.3 million cash portion of the settlement with the FHFA that has since been settled. Still, after subtracting that amount from the total, the early estimates were still calling for a settlement of nearly $14 billion.

Banks generally have reserves set aside to deal with worst-case-scenario settlements, so the reduced figure might mean Bank of America has billions more in reserves than they'll actually have to pay out.

The end of an era
Earlier this week, CEO Brian Moynihan said the Justice Department settlement is the last big settlement left over from the financial crisis. There are still a bunch of relatively small legal issues to work out, but as far as the high-dollar legal bills are concerned, this is it.

Since the settlements began in 2011, Bank of America has paid out more than $60 billion in settlements, legal fees, and to rebuy bad mortgages it sold.

Shares are trading at a very low valuation relative to historic levels, and a lot of the reason for this has to do with uncertainty surrounding both legal issues and the bank's capital plan.

BAC Price to Tangible Book Value Chart

As far as the capital plan is concerned, there is no reason to think the recently resubmitted version won't be approved.

The $4 billion accounting error which caused Bank of America to withdraw their original capital plan caused hardly any change in the reported capital ratios. Additionally, the bank is playing it safe by asking for less than the $4 billion in buybacks and 400% dividend increase than the first plan requested.

The financial crisis and its after-effects represent a period of time shareholders will be glad to put in the rearview mirror. The bank's retail business is growing, capital levels are fine, and there is a high probability dividends will increase once Bank of America's new capital plan makes its way through the review process.

Once the financial crisis issues are truly in the past, more of the market's focus will shift to what really matters: the banking business. Once this happens, Bank of America's shares won't be cheap forever.

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America. 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.

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