Here’s Why Bank of America Is Dead in the Water

Source: Thinkstock

Source: Thinkstock

Just when we thought the worst was probably over for the country’s second largest lender, Bank of America (NYSE:BAC), we found out that was far from the case. Negotiations with the Department of Justice (DOJ) hit a dead end this week, and the bank may now have to battle it out with the DOJ in the courts over a multi-billion dollar penalty.

The prospect of a protracted fight has drained investor enthusiasm. Shares, which just recently began to recover after a post-earnings slump, are beginning to fall again. This year to date BofA stock has lagged the S&P 500, falling about 3.2 percent.

According to The New York Times, negotiations between BoA and Department of Justice overmortgage settlements reached an impasse when the DOJ refused to accept the bank’s $12 billion offer to settle the investigations into BoA’s sale of assets backed by mortgages that had bombed. According to the publication, BoA’s offer falls short of the prosecutor’s demand for $17 billion, which would be the heftiest pay out by any bank so far, if the bank agrees to pay. BoA has already paid about $50 billion since the crisis in order to resolve cases of selling as much as $640 billion worth of questionable mortgage backed securities in the build up to the crisis.

The news could be unnerving for investors who expected to see BoA reach some resolution with DoJ, in line with a similar settlement reached between DoJ and JPMorgan Chase (NYSE:JPM) earlier this year. JPMorgan paid $13 billion on charges of miss-selling asset backed securities in 2007-08, when the financial crisis hit.

Apart from failed negotiations with the prosecutors, the bank is reeling under operational and economic pressures. One of the challenges facing BoA is a huge deposits base worth $1.13 trillion, as of the first quarter of 2014. The problem with such a large deposit base is that if interest rates begin to rise, then the bank will face severe re-pricing pressure on its deposits, unless there is a similar pickup in demand for credit as well.

The North Carolina-based bank has also been on the Consumer Finance Protection Bureau’s radar. Last month, BoA was asked to cough up $772 million in refunds for illegally charging its customer for credit monitoring services that were never received by the customers.

Investors have not been very happy about the bank going back on its plan of increasing dividends from 1 cent to 5 cents and to repurchase shares worth $4 billion under its capital distribution program, which could have been a good reward for the investors in troubled times like these. The investors now only hope that the bank is able to put the slew of litigations behind it and get on with its lending business.

But the bank’s chief financial officer, Bruce Thompson, told investors in the investors call on April 17 that legal costs going ahead will be hard to predict. Litigation expenses ballooned to about $6 billion on a pre-tax basis in its first quarter from $2.2 billion in the same quarter last year.

Worried over a stand-off with the prosecutors, uncertain interest rate environment, and weak economic growth, investors have stayed away from the stock for some time now. Stock trading volumes have almost stagnated this quarter. Though it gained 2.2 percent in the last six months, the stocks slipped consistently in the second quarter from $17.20 per share before April to $15.56 per share where it is currently trading.

But the headwinds aren’t expected to last forever. In the current quarter, analysts are expecting revenues to fall 3.7 percent on the year, but earnings are expected to edge up. The optimism stems from two places. One, the bank has been actively cutting expenses, as we saw in the first quarter; two, it has been putting aside less money for bad loans. Non-interest expenses in the first quarter were down 6 percent from the same quarter a year back. Loan write-offs were down by 45 percent, which indicated the quality of credit has much improved.

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