The nation's third largest bank by assets, Citigroup (C +5.43%), has agreed to pay Fannie Mae $968 million to settle claims that it sold faulty mortgages to the now-government controlled entity. But don't tell that to Citi's shareholders. Shares of the bank closed higher yesterday on the heels of the news, and they are on their way to doing so again today, up by 0.66% at the time of writing.
My colleague John Grgurich explained the apparent paradox yesterday. In his opinion, it boiled down to three factors.
First, and in my opinion foremost, the settlement clears up substantial uncertainty surrounding Citi's shares. As CitiMortgage CEO Jane Fraser noted, "This agreement resolves substantially all potential future repurchase claims from them for loan originations from 2000 to 2012." These claims had weighed on its valuation, as it had at other banks like Bank of America (BAC +3.18%), which reached its own settlement with Fannie Mae earlier this year.
Second, the settlement, while far from inconsequential, could have been far worse. Thanks to its near-fatal decision to acquire Countrywide, Bank of America's settlement amounted to more than $10 billion, mixed between cash payments and repurchase agreements. Given this, $1 billion doesn't seem so bad.
Finally, according to Citi, the bank's earnings won't take a hit from the settlement. This is because its previously set-aside reserves are more than sufficient to absorb the blow. That doesn't mean it's done setting aside reserves, but just that it won't have to accelerate the amount.
All of this being said, there's one thing to point out, here. That is, Citi must still settle analogous claims with Freddie Mac. Bank of America's case got off easy in this regard. In 2011, the nation's second largest bank by assets entered into similar settlements with both Fannie Mae and Freddie Mac. In the latter's case, however, its deal resolved not only any pending claims, but also all future claims. If nothing else, this shows the value of good attorneys.
Settlement or not, however, in both Citigroup and Bank of America's cases, there's reason to believe big banks will no longer be as profitable as they used to be. This is why some of the market's smartest investors have begun to cast their eyes on smaller and more ably run banks like the one identified in our free report, "The Stock Warren Buffett Wishes He Could Buy." To learn the identity of this high-flying bank before the rest of the market catches on, simply click here now.
