Bank of America Corp. reached an agreement to pay $8.5 billion to settle claims by investors who lost money on mortgage-backed securities purchased before the U.S. housing collapse, the bank confirmed Wednesday morning.
The payment is the largest such settlement by a financial-services firm to date, exceeding the total profits of the Charlotte, N.C., bank since the onset of the financial crisis in 2008. Bank of America's board approved the settlement on Tuesday, a person familiar with the matter said.
The settlement ends a nine-month fight with a group of 22 investors who hold mortgage-backed securities with an original value of $105 billion, including the giant money manager BlackRock Inc., the insurer MetLife Inc. and the Federal Reserve Bank of New York. The settlement covers not just the 22 high-profile holders but all investors in 530 separate bond deals. The original face value of all bonds covered by the deal is $424 billion.
A deal could embolden mutual-fund managers, insurance companies and investment partnerships to seek similar settlements with other major U.S. banks by arguing that billions of dollars in loans they bought before the housing collapse didn't meet sellers' promises or were improperly managed. Bank of America, Wells Fargo & Co. and J.P. Morgan Chase & Co. collect loan payments on about half of all outstanding U.S. mortgages.
Indeed, Bank of America said Wednesday morning it would take $14 billion in charges in its second quarter for the settlement as well as its future exposure to mortgage repurchase claims from government-run mortgage giants Fannie Mae and Freddie Mac and other private investors.
The dispute between Bank of America and the mortgage investors began last fall when they alleged in a letter to the bank that securities they scooped up before the financial crisis from Countrywide Financial Corp. were full of loans that didn't meet sellers' promises about the quality of the borrowers or the collateral. The investors also alleged Countrywide failed to maintain accurate files while managing the loans. Bank of America purchased Countrywide in 2008 for $4 billion.
In the agreement, Bank of America will hand $8.5 billion in cash to The Bank of New York Mellon Corp., which acted as the trustee for the bondholders and will distribute the funds to the investors. The trustee expects to submit a filing soon asking a New York state court to approve the transaction.
Bank of America will take a corresponding pre-tax charge against earnings for the second quarter. The after-tax cost to the bank would be roughly $5 billion, the bank said. Bank of America said Wednesday that, due to the mortgage settlement, the additional provision and other mortgage-related charges adding up to $6.4 billion, it expects to report a net loss of $8.6 billion to $9.1 billion in the second quarter, or 88 cents to 93 cents a share.
The mortgage-related woes highlight the challenges faced by large banks as they struggle to put the financial crisis behind them and soothe investor concerns about their future profitability.
The $8.5 billion settlement has the potential to put Chief Executive Brian Moynihan on the hot seat. The bank hopes that the deal will convince shareholders that many of the problems inherited from Countrywide are behind it a year and a half into Moynihan's tenure as chief, according to people familiar with the situation.
Some investors may be upset about such a large payment in the wake of Moynihan's pledge last year to engage in "day-to-day, hand-to-hand combat" against investors demanding that the bank repurchase bad loans--called "put-back" demands--and "not just do a settlement to move the matter behind us." In a conference call with investors in October, he said the bank would push back against investors whose attitude was: "I bought a Chevy Vega but I want it to be a Mercedes."
On June 1, he hinted at a new approach. "There's a point where fighting doesn't have any value," he said during an appearance in New York.
Earlier this year, the bank said its maximum possible loss from private mortgage put-back demands was $7 billion to $10 billion--above and beyond the $6.2 billion already reserved for probable mortgage-repurchase losses.
A multibillion-dollar charge would "wipe out most earnings in the first half of the year," banking analyst Mike Mayo said earlier this month, before news of the potential settlement. Bank of America earned $2 billion in the first quarter. Mayo had lowered his 2011 earnings-per-share estimate to 50 cents, from $1, based on an expectation that a settlement could amount to $7 billion.
Despite any hit to earnings, "the need to settle is compelling for momentum, morale and management focus," Mayo said. It would "help to eliminate a cloud of uncertainty over Bank of America."
Over the past year, the bank's shares have dropped 28% amid investor doubts about its ability to get its arms around an array of woes linked to the 2008 purchase of troubled mortgage lender Countrywide. The acquisition ballooned the size of Bank of America's mortgage portfolio to 14 million loans, from 4 million, just as the housing market was set to collapse. It saddled the bank with hundreds of thousands of delinquent borrowers and thrusting it into the middle of the foreclosure-paperwork crisis last fall.
It also exposed the bank to numerous requests from angry investors demanding that the bank buy back poorly performing mortgages, which had been packaged together and sold to them as securities.
The mortgage woes are one reason the nation's largest bank by assets is lagging behind U.S. rivals J.P. Morgan Chase and Citigroup Inc. (C), the latter which received more U.S. aid during the financial crisis. Shareholders are also worried about the impact of U.S. regulatory reform, lackluster revenues, higher capital requirements from regulators and weak loan demand.
Bank of America's request to raise its dividend in the second half of the year was rejected recently by the Federal Reserve--another embarrassment for the 51-year-old Moynihan.
The New York Fed, which got mortgage securities in the process of bailing out ailing firms, BlackRock and a collection of other well-known names on Wall Street picked the fight with Bank of America in a letter last October from Houston law firm Gibbs & Bruns LLP. Other investors that the letter claimed had been harmed were Freddie Mac, MetLife and Allianz SE's Pacific Investment management Co., or Pimco. Some invested on behalf of clients.
The letter objected to the handling of 115 bond deals issued by affiliates of Countrywide. The failure to properly handle the loans "has materially affected the rights" of the bondholders, the letter said.
The settlement covers 530 bond deals, Bank of America said Wednesday.
The day the letter was disclosed, the bank's stock tumbled 4.4%. The demand caught the bank by surprise and threatened to affect the relationship between BlackRock and Bank of America, which at the time owned a stake in the New York money manager. Moynihan and BlackRock Chief Executive Larry Fink talked by phone to diffuse any tension, said people familiar with the situation.
In premarket trading Wednesday, shares of the bank were up 3.5%.
Moynihan told analysts in October he wasn't interested in a large lump-sum payment to make the mortgage-repurchase issue go away. But in December, he reversed course and decided to begin settlement talks.
Several events persuaded the bank that a settlement would be wiser than a fight, according a person involved in the discussions. There was an unfavorable ruling in a mortgage-related lawsuit against the bank, which made it easier for a bond insurer to pursue claims against the bank.
Earlier this year, the bank reached similar settlements for smaller amounts with Fannie Mae and Freddie Mac and bond insurer Assured Guaranty Ltd. Fannie Mae and Freddie Mac agreed to a $3 billion settlement in January, and investors continued to pepper the bank with questions about its future exposure to repurchase liabilities.
"It's been more of an evolution than a revolution," this person said.
