Bank of America Does Its Mortgage-Settlement Thing

Today Bank of America announced a settlement over a previous mortgage settlement that had previously had another settlement. Also there's another, separate mortgage settlement in the works.
Blue skies ahead. Or behind anyway.

Bank of America reported mortgage settlements today. I mean, earnings too. There were earnings. But I've said that "My model of Bank of America is that it is a random number generator for paying mortgage settlements, with a bank attached," and that model is holding up rather well. Today there is this: 1

On July 15, 2014, Bank of America executed a definitive settlement agreement with AIG to resolve all outstanding residential mortgage-backed securities (RMBS) litigation between the parties. Under the terms of the settlement, AIG will file notices of dismissal in its securities lawsuits against Bank of America and its affiliates pending in California and New York federal courts. Also, AIG has agreed to withdraw its objection to the Bank of New York Mellon private-label securities settlement (Article 77 Proceeding).

The AIG settlement amount of $650 million was covered by litigation reserves as of June 30, 2014.

So what's happening here is: Bank of America did an $8.5 billion mortgage settlement in 2011. Yesterday AIG and Bank of America settled their disagreements over that previous settlement, as well as some other grievances. If you're a connoisseur of these things, you might notice that this is at least the second settlement relating to that BoNY Mellon settlement. I mean, not counting the initial settlement. It goes:

Separately, there's a Justice Department settlement in the works, previously $12 billion, or perhaps $13 billion, but now $13 billion, or perhaps $17 billion, or some other number. This settlement is not to be confused with Bank of America's $9.5 billion March settlement with federal regulators over mortgages sold to Fannie Mae and Freddie Mac, which in turn is not to be confused with its $11.6 billion 2013 settlement with Fannie Mae over those mortgages (or different ones?). It's mortgage settlements all the way down.

Today's earnings release says, "Bank of America has now resolved approximately 95 percent of the unpaid principal balance of all RMBS as to which RMBS securities litigation has been filed or threatened for all Bank of America-related entities," but the thing is, Bank of America's mortgage settlements are fractal. Each mortgage settlement contains infinite smaller mortgage settlements, each of which in turn contains infinite smaller mortgage settlements, etc., infinite times.

Since the beginning of 2011, Bank of America has made about $284 billion in revenue. Of that, it's spent about $25.6 billion -- 9 percent of revenue -- on litigation expense. It's kept about $19.1 billion -- 7 percent of revenue -- as net income. 2 Sometimes net income is more than litigation expense. Mostly not:

And this wildly understates matters, as not all of the money that Bank of America has been shoveling out the door in mortgage settlements is "litigation expense"; a lot of it is treated as bad-loan expense.

It's sometimes productive to remember that a bank is in the business of turning money into more money, and that it gets some 90 percent of its money -- its inputs -- from people other than its shareholders (bondholders, depositors, repo financing parties, etc.). If you remember that, then you won't be overly simplistic in thinking that a bank should be run for the benefit of its shareholders. Its shareholders, as claimants on the bank, are a tiny minority. They're an important claimant; their traditionally first-loss position gives them incentives to monitor the bank, and their residual-gain position gives them incentives to want to see the bank succeed. But if 90 percent of your money comes from creditors, you probably shouldn't be spending 90 percent of your time thinking about shareholders.

Once you start thinking that way, you might apply similar logic to the bank's income, too. Every quarter Bank of America does some trading and makes some home loans and takes some deposits and does all the businessy stuff of a bank. And every quarter Bank of America pays some money to employees and suppliers and whatever. 3 And at the end of the quarter it's got some money left over, and every quarter it ends up giving about half of that money to shareholders, 4 and about half to the people suing it and the lawyers defending it. 5 From a strictly financial perspective, Bank of America is -- still -- at least as much about paying for its 2007 mortgage business as it is about generating income for current shareholders.

I don't suppose that Bank of America is being consciously managed for the benefit of Fannie Mae, Freddie Mac, the Justice Department, and the lawyers. But the fact is, it's a better business for them than it is for shareholders. 6

What a depressing way to live. There is good news from Bank of America this quarter -- unlike its competitors, its fixed-income trading revenues are up 7 -- but it's a struggle to make that news feel relevant. Bank of America is still living at least half in the past.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

  1. From the earnings release. Here's the supplement, and the presentation.

  2. The revenue number is net revenue after provisions. The litigation expense number is pretax. The sources are earnings reports for litigation expense (some of the earlier ones say "mortgage litigation expense" rather than "litigation expense" and I can't be sure everything is commensurable) and Bloomberg for net income and revenue. I start in 2011 mainly because the litigation disclosure before then is too challenging for me. If you start with September 2011 -- to avoid that quarterus horribilis in June, which of course was mortgage-settlement-driven -- you get $22.5 billion for litigation expense and $25.9 billion for net income, so still pretty comparable. And of course that raises the important point that not all of the mortgage-badness stuff goes into "litigation expense" (only $2.2 billion went there in June 2011); lots of it goes into bad-loan expense.

  3. Here I pretend, utterly falsely, that compensation expense is sort of prior to the divvying up of the profits. Obviously, employees, like shareholders, are effectively residual claimants on a bank.

  4. In the form of retained earnings, obviously. Not so much dividends. That's a separate issue.

  5. And then says that the latter is a one-time cost.

  6. Also, so, okay, Bank of America's stock is worth about $163 billion at current prices. That's, you know, the present value of future cash flows to shareholders, discounted at an appropriate rate. If you assume:

    • cash flows to litigants and lawyers from Bank of America have, so far, been around equal to earnings available to shareholders (and much greater than actual cash flows to shareholders), and
    • that shows no signs of stopping, then

    That implies that Bank of America's pot of litigation has a present value north of $100 billion. Obviously, you won't believe that unless you think that Bank of America's mortgage litigation is an inexhaustible perpetuity. I ... kind of do?

  7. Driven, ironically, by mortgage trading.

To contact the author on this story:
Matthew S Levine at

To contact the editor on this story:
Toby Harshaw at

Before it's here, it's on the Bloomberg Terminal.