BofA Settles With Fannie Mae Over Reps And Warranties For $10 Billion, To Incur $2.7 Billion Pretax Hit

As had been widely expected, days before a National Mortgage/Foreclosure settlement is formally announced, the most exposed banks have started tying up the loose ends with the other nationalized entities. Sure enough, moments ago Bank of America just announced a $10 billion settlement with one of the GSEs - Fannie, whose CEO Tim Mayopoulous was BofA's former General Counsel and one of the people scapegoated by Ken Lewis. As just reported, as part of the agreement to settle representations and warranties claims, Bank of America will make a cash payment to Fannie Mae of $3.6 billion and also repurchase for $6.75 billion certain residential mortgage loans sold to Fannie Mae, which Bank of America has valued at less than the purchase price. These actions are expected to be covered by existing reserves and an additional $2.5 billion (pretax) in representations and warranties provision recorded in the fourth quarter of 2012. Bank of America also agreed to make a cash payment to Fannie Mae to settle substantially all of Fannie Mae’s outstanding and future claims for compensatory fees arising out of past foreclosure delays. This payment is expected to be covered by existing reserves and an additional provision of $260 million (pretax) recorded in the fourth quarter of 2012. Bottom line: hit to Q4 pretax earnings will be $2.7 billion. Yet, as BAC notes, despite the settlement, "Bank of America expects earnings per share to be modestly positive for the fourth quarter of 2012." Which means prepare for one whopper of a loan-loss reserve release for the quarter as more "earnings" are nothing but bookkeeping gimmicks.

As for the implications of this settlement, we learn two things:

i) as we have said since 2010, BAC has been very much underreserved on its total putback exposure and the additional $2.5 billion in provisions to settle with Fannie means that ongoing provisions over the last 5 quarters have been far too low as seen in this chart from the firm's latest earnings presentation:

ii) the $10 billion settlement with one GSE is put in the context of total reserves as of Q3, 2012, at $16.3 billion.

So with one of the GSEs out of the way, and with an additional $2.5 billion in reserves having to be established just to prefund this particular $10 billion settlement, one can see why the firm is so skittish in coming to a settlement over its private label exposure, which according to some is where the true fulcrum loss lies, and as per Piper Jaffray is estimated at tens of billions in total. Of this, MBI is the leading case study, which seeks $4-5 billion. So while the Fannie settlement was perfectly expected, as the government would hardly impair one of its darling banks by too much (and one wonders whether Mayopoulos did recuse himself of any negotiations), when it comes to private labels, there will be blood.

And while the additional provision may be $2.5 billion for just one Fannie, like for the final number to be far greater when all other exposures are settled, which include private labers, second-lien monolines as well as whole loans.

As a result, don't expect the bank to be paying much if any dividends in 2013 either, as the bulk of the free cash flow will once again be rerouted for loss provisions which will come, just a question of when.