Bank of America's second-quarter earnings outlook just got a lot worse thanks to a potentially huge litigation bill, according to analyst Dick Bove.
Bove, the vice president of equity research at Rafferty Capital Markets, now expects the second-largest U.S. bank by deposits to suffer a loss of 7 cents a share, down markedly from his initial estimate for a 32-cent profit. (FactSet consensus is 33 cents.)
The reason: Recent press reports indicating that BofA faces a settlement with regulators that will require it to pay between $10 billion and $13 billion. That's because of fallout from the financial crisis, in which the bank, along with Countrywide Financial and Merrill Lynch, both institutions it purchased during the crisis, issued some $640 billion in subprime mortgages.
Many of those loans ultimately defaulted, resulting in the worst economic downturn since the Great Depression. Over the past year or so, the Justice Department has gone after banks at the center of the crisis, but Bove said in this case it's not fair.
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"The securities in question were sold prior to 2008. It is unclear who sold them. However, it is believed that the bulk was sold by Merrill Lynch and Countrywide Financial prior to their acquisition by the bank," he said in a note accompanying the earnings downgrade. "Thus, once again the Justice Department is following its belief that the shareholders of Bank of America should be penalized for actions they never took."
Other analysts had varying views on the bank. Credit Suisse maintained a neutral rating on the bank despite talks of a settlement, SunTrust cut its price target to $17 from $19 and Deutsche Bank reiterated its "hold" rating.
A Bof A official declined comment either on Bove's earnings downgrade or the larger settlement issue.
Bove said the government should pursue action against the individuals who ran the companies rather than hitting shareholders.
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"This is justice in the United States at this time," he said. "If Bank of America pays this fine it will be closing in on $65 billion in payments for actions taken primarily by others."
The BofA news comes on the heels of a $13 billion settlement JPMorgan Chase reached with the government last fall.
Because BofA and the companies it bought out sold substantially more subprime securities than JPMorgan's $460 billion, the penalty could be even larger. The New York Times reported this week that the government's initial offer on the table was for $20 billion, though a number that high is unlikely.
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Although Bove maintains his "buy" rating on BofA, he said shareholders are going to get unduly penalized should the settlement go through.
"Two points should be considered for the future," he said. "First, it is highly likely that there will be more fines paid. Second, at no time will the board of this company defend the rights of its shareholders."
