In what is arguably the biggest step yet taken by Bank of
America (
BAC
) towards resolving its legacy mortgage issue, the country's second
largest bank has inked an agreement with Fannie Mae to settle all
differences over loans worth $1.4 trillion by paying the latter
$3.6 billion and also repurchasing mortgages worth $6.75
billion.
A large part of this settlement will be addressed using existing
reserves and provisions with the net impact of a $2.7 billion
reduction in Q4 2012 pretax income. Moreover, the bank also took
another giant stride towards trimming down its mortgage servicing
portfolio with its decision to sell off mortgage servicing rights
(MSRs) for nearly 2 million loans worth $306 billion. These
decisions, combined with an additional $2.5 billion in pretax costs
linked to other litigation and mortgage-related issues, a $700
million accounting cost from revaluation of its own debt, and a
$1.3 billion gain from foreign tax credits will reduce the bank's
fourth quarter earnings to a "modestly positive" figure.
We are in the process of updating our
$10 price estimate for Bank of America's stock
in view of these significant developments.
See our full analysis for Bank of
America
The Fannie Mae Settlement Removes The Sharpest Thorn In
BofA's Side
Bank of America has the dubious distinction of being the bank
with the most number of lawsuits filed against it in relation to
unfair mortgage origination and securitization practices over the
years leading to the economic recession of 2008. No doubt, the
acquisitions of Merrill Lynch and Countrywide Financial is what
aggravated the situation for Bank of America - a situation it has
spent tens of billions of dollars over recent years to deal
with.
The Federal National Mortgage Association (Fannie Mae) held
one of the biggest grudges against Bank of America for selling it
mortgages worth billions over the years by misrepresenting their
actual quality. Countrywide, in particular, attracted a lot of
scorn for its rampant sub-prime lending practices prior to its
collapse during the recession. Since it became clear that the
mortgage portfolio sold by Bank of America (and its acquired
divisions) were far lower in quality than claimed, Fannie Mae has
been pressurizing the bank to repurchase a large chunk of these
loans (see
BofA Feels the Heat From Fannie Mae Repurchase Demands
) - worth $11.2 billion at the end of Q3 2012.
This is why the settlement with Fannie Mae is so important as it
cleans the slate between the bank and the government enterprise and
will save millions in litigation expenses for both parties. The
settlement will have some profound impact on Bank of America's
business though as the repurchased loans will likely result in the
bank having to set aside more cash as reserves and provisions over
coming quarters to account for their poor quality. The impact of an
increase in mortgage provisions on Bank of America's share price
can be understood by making changes to the chart above.
And The Sale of MSR's Is In Line With Project New BAC
Goals
Bank of America has been watering down its mortgage business
over the recent years as it tries to get rid of its problematic
mortgage portfolio - and more importantly investors' doubts in the
quality of the portfolio. In the second half of 2011, the bank
implemented a series of changes to its mortgage business -
including the sale of its correspondent mortgage lending
division and the decision to discontinue wholesale lending and
reverse mortgages.
In line with the decision to focus more on direct customer
offerings, Bank of America is now cutting its mortgage servicing
portfolio by more than $300 billion. Of the near 2 million loans it
is selling off, more than 10% have not seen a payment in more than
60 days.
The decision serves the dual purpose of cutting down on the
servicing portfolio and reducing charge-offs in the future. The
MSRs have been sold to Nationstar Mortgage and Walter Investment
Management. ((Nationstar Mortgage Announces Agreement to
Acquire Approximately $215 Billion in Mortgage Servicing Assets
from Bank of America, Nationstar Mortgage News Releases, Jan 7
2013))
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