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Bank of America's Legal Problems Appear to Be Largely Over

By John Maxfield - Oct 30, 2015 at 11:22AM

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The bank's decision to exclude a formerly standard slide from its latest earnings presentation is a fortuitous sign.

If you looked closely, you may have noticed that something was missing from Bank of America's ( BAC 0.61% ) third-quarter earnings presentation. For the first time in 20 quarters, the $2.15 trillion bank did not include a separate slide revealing its exposure to representation and warranties claims, a particularly pernicious type of legal liability that's cost Bank of America more than $28 billion since the financial crisis.

The slide that Bank of America usually included showed two things:

  • First, the total outstanding value of representation and warranties claims, which arise when a bank sells shoddily originated mortgages to institutional investors.
  • And second, the trend in new claims received over the previous five quarters.

From the second quarter of 2014 through the first quarter of 2015, Bank of America's total outstanding representation and warranties claims grew from $20 billion all the way up to $25.8 billion. Over the same stretch, it received an average of $2.6 billion in new representation and warranties claims each quarter.

Data source: Bank of America's 2Q15 earnings presentation.

The question, in turn, is this: Why would Bank of America stop including this slide in its quarterly earnings presentations? Given the size of these liabilities, isn't this material information the bank should continue to highlight as conspicuously as reasonably possible?

The answer to these questions can be found in the second quarter, when Bank of America announced that a legal decision by New York's highest court has barred new crisis-related representation and warranties claims against it. This dropped Bank of America's outstanding representation and warranties claims by $6.8 billion in one fell swoop. The decision had a similar effect on incoming claims, reducing them to only $224 million in the three months ended June 30, compared to the previous quarterly average of $2.6 billion.

Given this, Bank of America's decision to exclude this slide in its third-quarter earnings presentation seems to confirm that these problems are indeed in the bank's rearview mirror. This should come as a relief to investors in the Charlotte, North Carolina-based bank, as it was possible that the bank had overestimated the impact of the second-quarter legal decision by the New York court.

With the lion's share of legal expenses seemingly behind it, Bank of America can now devote its attention to generating more revenue, an area where it lags far behind its competitors.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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