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Estimate of Future Legal Losses at Bank of America Reaches All-Time High

By John Maxfield – Feb 26, 2014 at 9:23AM

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On Tuesday, the nation's second largest bank by assets reported that its estimate of future litigation-related losses is almost double its previously announced forecast. What was behind the change, and what does it mean for Bank of America shareholders?

Make no mistake about it, Bank of America (BAC -1.29%) has made exceptional progress at atoning for its sins from the financial crisis -- and most notably its ill-fated acquisition of Countrywide Financial. But investors nevertheless got an unwelcome reminder on Tuesday just how much ground must still be covered.

According to the Charlotte-based bank's annual financial filing with the Securities and Exchange Commission, the extent of estimated future losses stemming from litigation is at an all-time high. As you can see in Figure 1, the bank's best guess at future litigation-related losses in excess of accrued liabilities tops out at $6.1 billion. This figure is $3 billion more than, or nearly double, the extent of estimated possible losses provided by Bank of America in its 2012 annual filing.

To be clear, figures like these are educated guesses at best. As the bank explains, if a future loss is both probable and estimable, it accrues an associated liability -- this is essentially equivalent to an expense as far as the income statement is concerned. If an anticipated future loss isn't sufficiently probable and estimable, the bank can nevertheless make an educated guess at its possible range (which is what the $0 to $6.1 billion range above refers to) but it can't accrue a liability. Finally, if a future loss is too speculative, and thus an estimate is neither probable nor possible, both the bank and its shareholders are essentially left in the dark with respect to its likely magnitude.

With this framework in mind, and assuming that a bank isn't egregiously overestimating its future legal losses (which seems unlikely given what it would communicate to legal adversaries), it's almost a guarantee that actual losses will nearly always exceed published estimates of future losses. Bank of America is no exception in this regard. As I've already noted, its estimated range from its 2012 annual report pegged the maximum figure at $3.1 billion in excess of accruals (see Figure 2). Meanwhile, the actual loss for 2013 was $6.1 billion -- for the record, its actual litigation-related loss in 2013 is indeed the same as its now-current estimate of future losses in excess of accruals.

It's hard at this point to say what caused Bank of America to nearly double its estimate of future litigation-related losses compared to the prediction in its previous annual filing. Certainly, the size of the recent JPMorgan Chase settlement with a variety of legal and regulatory bodies could have factored into the decision. On top of this, Bank of America's filing reveals an assortment of ongoing cases and investigations in which it's the target. Most notably, it disclosed a new investigation by authorities in North America, Europe, and Asia into its "conduct and practices in certain [foreign-exchange] markets over multiple years." But like I said, pinpointing any particular issue as the impetus for the increase is nothing more than speculation.

What should shareholders take away from this? To be honest, it's hard to say. On the one hand, it could be interpreted as good news -- that is, if it suggests that Bank of America is getting a better grasp on possible, as opposed to unknowable, losses. On the other hand, it serves as yet another reminder that there's still considerable work to be done by the executives at Bank of America before the nation's second largest bank by assets can finally close the chapter on the financial crisis.

John Maxfield owns shares of Bank of America. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America. 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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