Bank Stock Investors: Ignore Mortgage Settlement (Update 3)

Updated with market close information.

NEW YORK ( TheStreet) -- Investors should ignore Thursday's foreclosure settlement.

The $25 billion settlement between federal regulators, 49 states' attorneys general, and the largest loan servicers -- including Bank of America ( BAC), JPMorgan Chase ( JPM), Wells Fargo ( WFC), Citigroup ( C), and Ally Financial -- removes some headline risk for the banks, while providing some cash to millions of consumers who lost their homes, but the banks were already substantially reserved for their immediate $5 billion cash payout, and the loans subject to principal write-downs as part of the settlement, had already been substantially marked-down by the banks.

Not surprisingly, Bank of America is the largest participant in the settlement, to the tune of $11.8 billion. While that's a huge number, the company said that "The financial impact of the settlements is not expected to cause any additional reserves to be taken over those made during 2011."

The settlement does nothing to alleviate Bank of America's mortgage putback risk, mainly resulting from the purchase of Countrywide Financial in 2008, but also from the Merrill Lynch acquisition. The putback claims -- including the Federal Housing Agency's massive suit against 17 lenders in September -- could take years to work out. Then again, Bank of America "ended 2011 with $15.9 billion reserved to address potential representations and warranties mortgage repurchase claims."

Bank of America did say that the "$1 billion in refinancing assistance" it would provide under the settlement "is expected to be recognized as lower interest income in future periods as qualified borrowers pay reduced interest rates on loans refinanced."

So, whatever your previous opinion on Bank of America was, prior to the settlement, it would appear that nothing really has changed, other than the probable reduction of breathless headlines, bashing the company and its competitors for foreclosing on borrowers who haven't been paying what they agreed to pay.

Bank of America's shares have rallied 47% year-to-date, through Friday's close at $8.107, after sliding 58% in 2011.

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For truly long-term investors, who can commit for several years, Rochdale Securities analyst Richard Bove things that Bank of America will be a big winner, saying on Wednesday that the company has eventual "$3 in earnings power there," supporting a share price of $30 in three to four years.

For investors with a shorter-term outlook, Wells Fargo analyst Matthew Burnell maintained his "Market Perform" rating on Bank of America, but reduced his 2012 earnings estimate to 60 cents a share from 75 cents, and his 2013 estimate to a dollar from $1.25, because of the company's warning on lower net interest income because of the refinancing and principal forgiveness under the settlement.

The shares trade for 0.7 times tangible book value a, according to HighlineFI, and for 11 times the consensus 2012 earnings estimate of 71 cents a share, among analysts polled by Thomson Reuters.

Interested in more on Bank of America? See TheStreet Ratings' report card for this stock.

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JPMorgan Chase is committed to a $5.3 billion contribution to the foreclosure settlement, including $1.1 billion for "payments to borrowers," roughly "$500 million of refinancing relief to certain 'underwater' borrowers whose loans are owned by the Firm," and "approximately $3.7 billion of additional relief for certain borrowers."

The company said that while it "expects to incur additional operating costs to comply with portions of the global settlement, "financial performance from prior periods has reflected the estimated costs of the global settlement," and that the effect of the settlement on "financial results for the first quarter of 2012 and future periods will not be material."

Bank of America Merrill Lynch analyst Guy Moszkowski said on Friday that JPM's share of the settlement consists of "$1.1 B in 'hard dollars' and $4.2 B in 'soft-dollars,'" which was "in line with what we would have expected."

In his comments on JPMorgan Chase and Citigroup, Moszkowski said that for both companies, "the hard-dollar costs are covered by litigation reserves that were set aside over the past 15 months or so," while "the principal-forgiveness and loan-modification costs are to a great extent covered by existing Loan Loss Reserves."

JPMorgan Chase's shares have returned 14% year-to-date, through Friday' close at $37.61, after a 20% decline in 2011. The shares trade for 1.2 times tangible book value, and for eight times the consensus 2012 EPS estimate of $4.67.

Interested in more on JPMorgan Chase? See TheStreet Ratings' report card for this stock.

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Wells Fargo also agreed to contribute $5.3 billion to the foreclosure settlement, including $900 for refinancing relief, "$3.4 billion in consumer relief programs," and "$1.0 billion paid directly to the federal government and the states for their use to address the impact of foreclosure challenges as they see fit."

The company said that as of Dec. 30, it had "fully accrued for the Foreclosure Assistance Payment," and that "the expected impact of the Consumer Relief Program was covered in our allowance for credit losses and in the non-accretable difference relating to our purchased credit-impaired residential mortgage portfolio," meaning that loans acquired as part of the Wachovia acquisition at the end of 2008 had already been sufficiently written-down.

The company did say that the refinancing portion of the settlement would "be recognized over a period of years in the form of lower interest income."

Bank of America Merrill Lynch analyst Erica Penala said on Friday that the impact of the settlement on her earnings forecasts for Wells Fargo was "minimal, as, the $900mn set aside would be taken over time and is just 2% of WFC's annual net interest income capacity near-term," adding that "WFC has already reduced the value of its mortgage servicing rights by $2.6bn, partly to reflect higher servicing costs."

Penala reiterated her "Buy" rating for Wells Fargo, with a price objective of $33, "despite the run in the stock, especially as peer valuations appear quite stretched relative to both near-term and even 'normalized' EPS power."

Wells Fargo's shares are up 10% year-to-date through Friday's close at $30.27, after pulling back 10% in 2011. The shares trade for 1.8 times tangible book value, and for 10 times the consensus 2012 EPS estimate of $3.20.

Interested in more on Wells Fargo? See TheStreet Ratings' report card for this stock.

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Citigroup will contribute "approximately $2.2 billion," to the foreclosure settlement, and expects that "existing reserves will be sufficient to cover customer relief payments and all but a small portion of the cash payment called for under this settlement."

However, the company will "adjust its fourth quarter and full year 2011 financial results to reflect an additional $84 million (after tax) charge," along with an additional $125 million in after tax charges, "in connection with the resolution of related mortgage litigation."

Moszkowski said that Citi's portion of the settlement consisted of "$0.4 B in 'hard dollars' and $1.8 B in 'soft-dollars'", in line with what he had expected.

Burnell made slight reductions in his 2012 EPS estimate for Citigroup to $3.95 from $4.00, and his 2013 estimate to $4.70 from $4.75, "due to lower expected net interest income from the firm's legacy US mortgage portfolio, which is housed in Citi Holdings."

Citigroup's shares were up 25% year-to-date through Friday's close at $32.92, after a decline of 44% in 2011.

Like Bank of America, Citi's shares trade for 0.7 times tangible book value, however, the shares trade at a much lower eight times the consensus 2012 EPS estimate of $3.99.

Interested in more on Citigroup? See TheStreet Ratings' report card for this stock.

-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

To follow the writer on Twitter, go to http://twitter.com/PhilipvanDoorn.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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