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Bank of America: Not Worth the Risk

Stocks in this article: BAC FNMA.OB FMCC.OB

NEW YORK ( TheStreet) -- Bank of America (BAC) may be cheap, but for many investors and analysts, there's no reason to take on so much risk.

"There simply is no way to really gauge at this point the potential downside risk on Bank of America," says Michael Yoshikami, CEO of YCMNET Advisors, which does not own shares of Bank of America, "There just seems to be no end to the drama."

The drama is all around mortgage risk, especially the risk known as "putbacks" or "representations and warranties."

Shares fell more than 20% Monday

For those who need a refresher, putbacks relate to mortgage loans that were pooled together and stuffed into bonds known as mortgage-backed securities (MBS) ahead of the financial crisis.

The buyers of those MBS, which include Fannie Mae (FNMA.OB), Freddie Mac (FMCC.OB) and large institutional money managers such as insurance companies and pension funds, have in many instances lost a great deal of money on their investments. Many of them are taking issue with the way those investments were cobbled together, arguing that the mortgages that were put into those MBS were fraudulent or in some way did not meet the criteria originally promised.

Those investors then want to "putback" the securities onto the banks and be compensated for their losses.

Bank of America has set aside nearly $28 billion to address its exposure to this issue, but is expected to receive some $418 billion in claims on more than $2 trillion in mortgage loans made between 2005 and 2008, according to a July 28 report from Deutsche Bank. That compares to $398 billion in expected claims for Citigroup (C) First Horizon National Corp. (FHN), JPMorgan Chase (JPM), PNC Financial (PNC), SunTrust Banks (STI) and Wells Fargo (WFC) combined.

But the Deutsche Bank report came out July 28; before the alarming market selloffs of the past few days have raised fears of a double dip recession. If we have a double dip, that $418 billion number could prove too conservative.

Also striking many commentators as too conservative were Bank of America's estimates that home prices will rise by 1% in 2012. Many of the bank's assumptions about potential putback requests it receives are based on that premise, bank CFO Bruce Thompson told investors on a conference call Wednesday.

Similarly, Thompson said many assumptions are based on an $8.5 billion settlement agreement reached with 22 institutions, and announced June 29. However, that settlement has been challenged by New York Attorney General Eric Scheiderman, who argues along that the deal is far too cozy -- involving a group of institutions that have a financial incentive to go easy on Bank of America.

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