BofA Cleans House With Fannie Mae Settlement And $300 Billion Sale Of Mortgage Servicing Rights

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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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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