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Analyzing a Possible BofA Settlement

After this announcement the majority of the legal issues will be behind the company.
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There are reports out that Bank of America (BAC) is set to announce a settlement with the DOJ, the state AGs and the residential mortgage-backed securities workgroups over its mortgage practices for $16 billion to $17 billion.

The speculation floating around has been for a figure between $12 billion and $20 billion and if it comes in at the high end, it is an enormous number and a costly one, driven by the $4 billion acquisition of Countrywide in 2008. But it is another overhang removed and follows yesterday’s news that the company was approved to pay out a dividend, the first time in seven years, following its resubmission of its CCAR plan to the Feds.

If the $9 billion cash component is accurate (and the remainder being for consumer relief programs) we estimate the company will have to take a $2 billion to $3 billion charge in 3Q (25 cents a share) since it likely has around $7 billion set aside for the settlement. The likely impact to tangible book value would be a hit of 4-5% and a 40-50 bps decline to its Common Equity Tier 1 ratio (at 2Q this ratio stood at 9.5%).

There are a lot of moving parts to this, but after this announcement the majority of the legal issues will be behind the company and sets up for a cleaner earnings run-rate going forward. The two other legal issues facing BAC are LIBOR and FX lawsuits but they are in early innings of being settled and the company is one of the smaller players in each of these cases.

Its 2015 earnings expectations are $1.50 a share and over time earnings power of $2 is still achievable, but it needs some help from a steeper yield curve and buybacks, as well as for the U.S. economy to continue to show improvement (which we expect). Every 100 bps increase in short rates equates to $3.4 billion in net interest income (or an 8-10% impact) and 15-20 cents to earnings per share. With the 10- year Treasury at 2.45%, this is a big headwind. But the profitability side to the story remains on track (with $2 billion of cost takeouts per quarter for the next two quarters and another $800 million in 2015) and we expect in 2015 the company will be approved for share repurchases as it works through all of these settlements this year and gets it behind them.

Regards,

Jim Cramer, Stephanie Link, and TheStreet Research Team

DISCLOSURE: At the time of publication, Action Alerts PLUSwas long BAC.