BofA Mortgage Settlement Has Bank-Sector Ramifications (BAC, C, WFC, FAS)

Bank of America Corporation (NYSE: BAC) is showing investors this morning that its book value may actually be more relevant than what it had been given credit for.  The largest bank by deposits in America has settled for $8.5 billion issues pertaining to the Countrywide mortgage repurchase and servicing claims. This will effectively resolve nearly all of its legacy Countrywide-issued first-lien residential mortgage-backed securitization repurchase exposure.  This represents 530 trusts with an original principal balance of $424 billion.

Another issue driving banks this morning is that the Bank of America Merrill Lynch analyst team has decided to raise Citigroup, Inc. (NYSE: C) to a Buy rating with a $53 price target.  Bank of America cannot cover itself, so when banks upgrade or downgrade their peers some believe that this is a signal that they are actually just upgrading their own position to the markets.

The agreement includes a cash payment of $8.5 billion to be made after final court approval of the settlement. Bank of America also intends to record an additional $5.5 billion provision to its representations and warranties liability for both Government-Sponsored Enterprises (GSE) and non-GSE exposures in the second quarter of 2011.  The bank will Will provide an additional $5.5 billion in its second quarter as representations and warranties exposure.  The bank noted that it “will have settled or provided additional reserves for a substantial portion of the original principal balance of representations and warranties exposure.”

Here is where the difference is between GAAP and non-GAAP reporting.  It is huge.  The bank now expects to report second-quarter loss of $0.88 to $0.93 per share if you include a goodwill impairment charge of $2.6 billion. If you exclude the items, the bank sees earnings of $0.28 to $0.33 per share.  Without the effect of the charges and without other non-recurring items, Thomson Reuters consensus has estimates of $0.28 EPS for the quarter.

The agreement announced to today follows two recent settlements aimed at resolving Bank of America’s RMBS repurchase exposure.  In January, Bank of America announced agreements with two of its largest counterparties Fannie Mae and Freddie Mac. In April, the company and Countrywide signed an agreement with Assured Guaranty Ltd. to resolve outstanding repurchase claims where Assured provided financial guarantee insurance.

What is interesting about today’s news is that this may not be the complete end to BofA’s Countrywide issues.  Some put-back risks are still believed to exist.  Our take is that if you asked ten officers on what that exposure really is, you’d get ten different answers.

Bank of America shares are up 3.6% at $11.21 after a $10.82 close yesterday and against a 52-week range of $10.40 to $15.72.  Citigroup’s stock is up 2.1% at $40.99 and its 52-week range is $36.20 to $51.50.

If you consider the mortgage exposure trade, today’s news may be a larger indirect win for Wells Fargo & Co. (NYSE: WFC).  Its shares are up 2.6% at $28.22 and its 52-week trading range is $23.02 to $34.25.

Direxion Daily Financial Bull 3X Shares (NYSE: FAS) almost seems to be an under-reaction so far.  That may be due to tracking error and due to the market not yet being open.  The triple-leverage financial bull ETF is up 3.5% at $24.62 and its 52-week trading range is $17.05 to $34.29.

The beat goes on.

JON C. OGG