Bank of America Poised to Make Record Settlement

By Devlin Barrett, Dan Fitzpatrick and Christina Rexrode, The Wall Street Journal

06 June 14

At Least $5 Billion Expected to Go to Consumer Relief

ank of America Corp. BAC +0.71% is in talks to pay at least $12 billion to settle civil probes by the Justice Department and a number of states into the bank's alleged handling of shoddy mortgages, an amount that could raise the government tab for the bank's precrisis conduct to more than $18 billion, according to people familiar with the negotiations.

At least $5 billion of that amount is expected to go toward consumer relief—consisting of help for homeowners in reducing principal amounts, reducing monthly payments and paying for blight removal in struggling neighborhoods, these people said. As the negotiations with the government heat up, the bank is being pressed to pay billions more than the $12 billion it is offering.

The North Carolina bank's total tab to end government probes and lawsuits related to its conduct in the runup to the financial crisis is increasingly likely to surpass the record $13 billion that J.P. Morgan Chase JPM +0.41% & Co. paid last year to settle similar allegations, these people said. Bank of America has already struck a $6 billion settlement, by the Justice Department's measure, with the Federal Housing Finance Agency.

If finalized, a settlement on that scale would mark another major penalty for a large financial institution, as the Justice Department presses a number of cases against global banks.

The potential tab would leap ahead of other large penalties levied by the Justice Department and U.S. regulators. Even at a giant firm like Bank of America, the second-largest bank in the country by assets, a $12 billion fine would exceed the firm's 2013 profit of $11.43 billion. That profit was the bank's highest in six years, but the looming record legal settlement threatens to break the firm's momentum under Chief Executive Brian Moynihan.

The bank's shareholders have been bracing for a big settlement since April's quarterly earnings announcement. The bank swung to a surprising loss because it set aside more money than expected for legal expenses. It said then that the charges were for previously disclosed mortgage issues, a hint that it was referring to Justice Department negotiations.

Bank of America's legal charges have been a bane to its earnings, with the bank paying more than $60 billion since the financial crisis to settle lawsuits and buy back mortgage securities, said a person close to the bank. At an investor conference last week, Mr. Moynihan noted that the impending Justice Department settlement is a remaining wild card. "Of the big stuff," he said, "that's really the one that's left out there."

Paying at least $5 billion to help homeowners is part of a broader scenario Bank of America has floated, in which it would pay a total $12 billion in addition to the previous $6 billion FHFA settlement, these people said. That $12 billion would include both "hard money," or fines, and "soft money," or consumer relief. The bank has floated the idea of paying more than half of its settlement via soft money.

Government negotiators, however, are pushing the bank to pay billions more and put up more cash as part of the deal. Under the terms of a recent proposal made by the bank, at least half of the settlement would be in the form of help for homeowners, but that can be done in ways that make the actual cost to the bank significantly less than a direct cash payment to agencies.

Talks between the two sides have heated up in recent days, with meetings taking place at the Justice Department on Monday and the week before, these people said.

Still it is unclear when they might reach a tentative settlement given that they still remain far apart on the size of any penalty to be levied by the Justice Department.

The consumer-relief portion of a settlement would likely include measures similar to those used in the J.P. Morgan deal—reductions of mortgage principal for some customers, reductions of monthly payments for others and money spent on blight removal in parts of the country where the housing downturn left abandoned eyesores, these people said.

Under the terms being discussed, Bank of America would pay at least $1 billion more in consumer relief than the $4 billion J.P. Morgan agreed to spend on those efforts in November as part of its settlement of a government civil probe into how it packaged shoddy mortgages into securities.

If the two sides cannot reach a deal, the Justice Department would have to decide whether to file a civil lawsuit against the bank.

Attorney General Eric Holder has said that before he leaves his job, he wants to resolve a number of high-profile probes of financial firms' conduct leading up to the economic collapse. He has also said that he views the structure of the J.P. Morgan deal as a template for deals with other banks, and that the consumer relief issue was an important component to reaching a settlement. Some of the consumer-relief measures are novel, such as blight removal, and dollars spent by the bank on certain areas are worth more to them than dollars spent elsewhere.

The sometimes creative terms of consumer relief mean the bank could find ways to lessen the actual cost of a settlement.

For instance, in the J.P. Morgan settlement, the bank agreed to provide at least $1.2 billion in mortgage-principal reduction to customers —but for every dollar of principal reduction granted by the bank in the hardest-hit parts of the country, it will get $1.25 worth of credit toward the settlement. Depending on the details of which mortgages they target for principal reduction, the bank could boost that to as much as $1.43 toward the settlement cost. Another condition of the J.P. Morgan deal was that an outside monitor, approved by both sides, would oversee the bank's spending on consumer relief.

Bank of America was a big player in mortgage securitizations in the run-up to the financial crisis. Analysts at Sanford C. Bernstein & Co. calculate that Bank of America and its subsidiaries issued $965 billion in private-label, mortgage-backed securities between 2004 and 2008. J.P. Morgan and subsidiaries issued $450 billion.

A significant portion of Bank of America's mortgage-backed securities were made by Countrywide Financial Corp., which it bought in 2008. A major portion of J.P. Morgan's securities were issued by Bear Stearns and Washington Mutual. WMIH -1.08% J.P. Morgan purchased Bear Stearns Cos. and the banking operations of Washington Mutual Inc. in 2008.

Some investors weren't fazed by the size of the potential settlement.

Bill Smead, chief investment officer of Smead Capital Management in Seattle, which owns 2,625,338 Bank of America shares, said "it would only make sense that it would rival or exceed J.P. Morgan's."

Mr. Smead is also sanguine about the firm.

"The bad news is all six to eight years old, and the good news is all in the future," he said. "As a long-term stockholder, that's what you want. You want the bad news to be backward-looking and the good news to be forward-looking."

Mr. Smead isn't planning on selling any of the stock his firm owns as a result of the negotiations and said he thought the $5 billion or more that could go toward consumer relief would help stimulate the economy.