Bank of America 'Worst Case' Could Worsen

So much for the GSE issue being resolved.

Nomura analyst Glenn Schorr highlighted his concern in a question during the call to outgoing CFO Chuck Noski

"I think following the partial settlement with the GSEs, I and others might have thought with $5 billion plus in reserves, we might see a leveling off on the provision, but another billion with over half going to the GSEs, I'm assuming that's for the Fannie stuff that wasn't settled, and just curious on how you think about that as a, you know, an annoying run rate that's with us for a few more quarters or you feel like what percent of the pipe are you through now on the GSEs?" Schorr asked

Noski's answer? About 75% through.

So that's the first bucket of mortgage repurchase risk. Not finished, despite the big fourth quarter settlement. About 75% done, according to Noski.

The second bucket of risk refers to so-called "private label" MBS. This is MBS that isn't guaranteed by the GSEs.

This is where the much-discussed $7 billion to $10 billion number comes in.

Those figures don't refer to total potential private label exposure, but rather to additional capital that may need to be set aside. Since Bank of America has already put aside $5.4 billion, add another possible $7 billion to $10 billion to that and you have a total exposure that could be as much as $12.4 billion to $15.4 billion in the private label bucket.

Or it could be more if home prices continue to fall. Though Bank of America set aside $1 billion against ongoing GSE claims and a settlement with monoline bond insurer Assured Guarantee (AGO), it did not reduce its estimate of up to $10 billion in additional exposure--a fact that puzzled Morgan Stanley analyst Betsy Gracek.

"You would expect with the settlement and the additional accruals that 7 to 10 would go down and that is largely offset by [housing market] deterioration," Noski explained.

The $1 billion provision also surprised Sandler O'Neill analyst Jeff Harte, who had a "buy" on Bank of America and expected just a $150 million provision. So far, at least, Harte is still recommending the shares, which were down 1.6% early Friday afternoon.

To be sure, much of the increased capital Bank of America is setting aside may eventually never be used. Just because claims are being filed doesn't mean Bank of America will have to buy the mortgages back, and even if it does, the mortgages themselves could recover.

Still, as long as those reserves keep climbing, it is likely Bank of America's share price will keep falling as it did on Friday.

-- Written by Dan Freed in New York.

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