Bank of America: Settlement Loser

NEW YORK ( TheStreet) -- Bank of America ( BAC) was the loser among the largest U.S. financial companies on Friday, with shares pulling back 2% to close at $8.81.

While investors were waiting for an expected downgrade of Spain's bonds by Moody's Investor Service, the broad indexes pared earlier losses, after an independent audit showed that Spain's banks had a capital shortfall of "only" 53.75 billion euro, which was far less than the 100 billion bailout credit line already agreed to by the European Union.

Back home, the Institute for Supply Management announced that the Chicago Purchasing Managers Index fell to 49.7 in September from 53 in August, for its lowest level in three years. An index reading below 50 indicates contraction. On a brighter note, ISM said that "among the Business Activity measures, five of seven posted declines as New Orders fell below 50 and Order Backlogs contracted for the fourth of the past five months. Prices Paid showed the biggest gain in nearly two years and Supplier Deliveries moved back above 50."

The KBW Bank Index ( I:BKX) declined slightly to close at 49.56, with 16 of the 24 index components showing declines to round out the week.

After reversing their 2% gain on Thursday, Bank of America's shares have now returned 59% year-to-date, following a 58% during 2011.

The shares trade for 0.7 times their reported June 30 tangible book value of $13.22, and for ten times the consensus 2013 EPS estimate of 91 cents. The consensus 2012 EPS estimate is 55 cents.

Bank of America on Friday announced it had agreed to pay $2.43 billion to settle a class action suit brought in 2009 by investors against the company and "certain of its officers and directors," over claims that the bank and its executives made misleading statements when the company acquired Merrill Lynch.

The settlement has to be approved by Judge Kevin Castel in the United States District Court for the Southern District of New York.

In addition to litigation expenses of $1.6 billion, Bank of America said its third-quarter results would be "impacted by approximately $1.9 billion (pretax) in negative fair value option (FVO) adjustments and debit valuation adjustments (DVA) related to the improvement in the company's credit spreads, and the previously reported charge of approximately $800 million to income tax expense for changes in the U.K. corporate tax rate and the related effect on the deferred tax asset valuation."

The above items "are expected to negatively impact reported third quarter EPS by approximately $0.28," the company said.

Before Bank of America's announcement, JPMorgan Chase analyst Vivek Juneja reiterated his "Overweight" rating for the company, and said "we are establishing a December 2013 target of $11.50, which is based on 0.8x price to our YE 2013 tangible book value multiple, a 50% discount to expected peer median tangible book value multiple of 1.5x," and said he expected "BAC to trade at a discount near term due to continued headline risk and some pressure on revenues."

Juneja said that his firm continues to rate Bank of America favorably "longer term relative to our universe due to significant benefit from potential housing market recovery, potential for significant increase in normalized earnings, ongoing improvement of capital levels, relatively attractive valuation, and position as a leading retail and commercial banking franchise in the US," and that the company's "normalized earnings should benefit from large cost cutting program under way, reduction in the very large legacy asset servicing and other credit related expenses as housing market continues to improve, and decline in litigation expenses."

Following Bank of America's announcement, Sterne Agee analyst Todd Hagerman said that "turning the page on the embattled BAC/MER combination represents another incremental positive step for BAC. However, the company's legacy mortgage exposure, as well as the seemingly never-ending litigation exposure, suggests management will continue to struggle to meaningfully right-size the cost base and begin to monetize the restructured balance sheet anytime soon."

"We find it simply amazing the sheer magnitude of value destruction over the years," Hagerman said, "largely tied to BAC's legacy management team--who effectively walked away relatively unscathed to the detriment of shareholders and loyal employees. To be sure, w/the likelihood of additional legal settlements to follow over the next 12-24 mos., the bill is surely set to increase."

Hagerman has a neutral rating on Bank of America, with a $9 price target.

While Merrill Lynch may eventually turn into Bank of America's powerhouse, BAC still has to turn the corner on its mortgage putback risk, springing from both the Merrill and Countrywide acquisitions. Total mortgage repurchase demands against the company increased 41% during the second quarter alone, to $22.7 billion, as of June 30.

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

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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.