Bank of America is completing an agreement to pay $8.5 billion to settle a lawsuit by investors who purchased mortgage securities that soured when the housing bubble burst, representing what is likely to be the single biggest settlement tied to the subprime mortgage boom and the subsequent financial crisis of 2008.
The settlement would wipe out the company's earnings in the first half of this year, while encouraging powerful private investors to extract payouts from other banks that bundled troubled home loans and sold them as sound investments.
The proposed settlement is with a group of large investors including Pimco and BlackRock, as well as the Federal Reserve Bank of New York. Together they hold $56 billion in mortgage-backed securities from Bank of America, based in Charlotte, N.C.
The securities affected by the deal come from Countrywide Financial, the subprime mortgage lender whose practices have come to symbolize the excesses of the housing boom. Bank of America bought Countrywide in 2008.
The settlement goes beyond the securities owned by these investors, however. It covers nearly all of Countrywide's first-lien mortgages, which total $424 billion worth of original, unpaid principal balances. As a result, investors beyond those that are concluding the settlement stand to benefit.
Once it is approved by the company's board, the settlement will require court approval. Bank of America is expected to take a $5 billion after-tax charge in the second quarter to cover the payout.
The $8.5 billion settlement represents just a portion of the bank's total exposure to faulty mortgage bonds, much of which comes from the Countrywide loans.
Last fall, analysts warned that the toll of legal action from the investors and other private holders could total tens of billions of dollars, but the proposed deal would lift some of that uncertainty.
While the board has yet to approve the settlement, both sides are aiming to have it done by Thursday, according to a person close to the negotiations. Bank of America would deliver the money to the trustee for the securities, Bank of New York, which would distribute it to the institutional investors.
Bank of America does not anticipate having to raise capital or sell stock to raise the money for the settlement.
Still, other risks loom from the fallout of the subprime mortgage crisis — for Bank of America and its giant peers. All 50 state attorneys general are in the final stages of settling an investigation into abuses by the biggest mortgage servicers and are pressing the banks to pay up to $30 billion in fines and penalties.
What's more, insurance companies that backed many of the soured mortgage-backed securities are also pressing for reimbursement, arguing the original mortgages were underwritten with false information and did not conform to normal standards.
Bank of America, JPMorgan Chase, Citigroup and Wells Fargo have the greatest exposure to the legal claims over the faulty mortgage bonds. Together, they are likely to absorb roughly 40 percent of the industry's mortgage-related losses.
The huge settlement represents a sharp turnabout from the combative position that Bank of America's CEO, Brian Moynihan, initially adopted last fall when the legal effort by the investors began.
Not long after that, however, the bank started negotiations with the investor group, led by a Houston lawyer, Kathy Patrick. And in January, it reached a settlement with Fannie Mae and Freddie Mac, the government-controlled housing giants, to buy back $2.5 billion in troubled mortgages.
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