Bank of America -- Expect the Unexpected: Street Whispers

Updated to include Moody's comments in the 13th graph.

NEW YORK ( TheStreet) -- Bank of America's ( BAC) surprise $2.43 billion shareholder settlement on its crisis-time acquisition of Merrill Lynch on Friday is the next in a string of unexpected billion dollar losses and wrecked quarters. Investors should continue to expect negative surprises as the bank and its chief executive Brian Moynihan struggle to move past the crisis.

In fact, Friday's larger than expected legal settlement and an expected hit to Bank of America's third quarter earnings and capital levels give investors a clear signal why the bank's shares aren't expected to recover materially from the crisis anytime soon.

The loss -- combined with the steep discount that Bank of America trades relative to its liquidation value -- highlight a future unexpected surprises that could legal settlements, writedowns or provisions against future liabilities. Until investors have numerical certainty on Bank of America's various exposures, some analysts see little reason for shares to recover substantially.

Jim Sinegal, a large cap bank analyst with Morningstar, sees Bank of America's larger than provisioned for Friday shareholder settlement as yet another reason why legal issues stemming from the crisis will take a long time to resolve and will depress the bank's normalized earnings outlook and share prices for quarters to come.

"It's something that has been hanging over the stock for a long time and I don't think that's going to change anytime soon," says Sinegal of future legal costs, highlighted by the bank's ongoing litigation over mortgage securities with Fannie Mae and Freddie Mac. "The stock really doesn't recover until it's behind them," he adds.

Because Friday's settlement over Merrill Lynch came in roughly $1.2 billion more than Bank of America had provisioned for, the bank will wipe out roughly six months of progress on capital and depress overall 2012 profitability while cutting 28 cents from the Bank of America's third-quarter earnings. Both KBW and Wells Fargo analysts now forecast the bank will post a loss for the third quarter.

Earnings excluding charges, litigation and the improvement in its credit spreads, earnings may range between 15 cents and 30 cents, respectively, analysts said.

"The $2.4 billion settlement came in higher than expected as some part of the third quarter's $1.6 billion in litigation expense comes from an additional BAC/MER case accrual," wrote KBW analyst Jefferson Harralson, in a Friday note to clients. "We are left to guess that the case was settled for $0.8 to $1.2 billion more than what had been accrued," he added.

Although Bank of America shares are up nearly 60% year-to-date, the top performer on the Dow Jones Industrial Average those gains represent a recovery from post-crisis lows hit in 2011 and still keep the bank's shares at half of post-crisis highs near $20 a share hit in 2010.

Part of the problem for Bank of America compared with peers like JPMorgan Chase ( JPM) is that the bank as consistently surprised investors and analysts to the downside, reporting a string of negative earnings hits.

"One thing that I don't think Moynihan has done well which the best managers do well is under promise and over deliver," says Sinegal of Morninstar. "I think that's something that Jamie Dimon has done a good job of, that's why he gets so much credit," he adds.

Seen in that light, Friday's settlement represents just another negative earnings surprise on the heels of quarter after quarter of one-time charges related to the bank's activities prior to the financial crisis. Those losses include shareholder lawsuits against Bank of America on a litany of disclosures, settlements with state attorney generals on underwriting at its Countrywide unit - another hotly contested acquisition -- and legal battles with Fannie Mae and Freddie Mac on whether it misrepresented the quality of mortgage bonds it sold both government-sponsored agencies.

Moody's highlights in a Monday note that the shareholder settlement on Merrill Lynch may "be a step in the right direction" for Bank of America, but the ratings agency also notes a litany of liabilities remain for the bank to work through.

" We believe the bank's earnings are under pressure on a variety of fronts, and are likely to remain weak until more of these matters are resolved," writes Moody's credit bank analyst David Fanger, in a Monday report, noting that mortgage repurchase costs may exceed the $15.9 billion that Bank of America has provisioned for as of June 30. Still, Fanger downplays concerns that future writedowns will significantly erode Bank of America's capital base.

Excluding the balance sheet and cash costs that Bank of America may continue to accrue as it tries to resolve crisis-time liabilities, Nancy Bush, the head of research firm NAB Research highlights that it's earnings outlook and competitive positioning remain cloudy.

While Bush says Friday's charge will create a "lost quarter" for the bank, she says future writedowns aren't the biggest issue for Bank of America. "The biggest issue is for Bank of America to get into an interest rate environment where it is not detrimental to be operating one of the largest branch network in the nation," says Bush. Currently, deposit-taking banks are facing pressure on interest rate earnings as the Federal Reserve maintains a policy of near zero interest rates, now expected until 2015.

"When the interest rate environment normalizes, it is extremely important that they have their retail strategy set in place and ready to go. That's the biggest challenge facing them right now without a doubt," says Bush.

For more on why interest rates will color normal bank earnings in coming quarters, see Fed-based earnings destruction may hit hard in 2013.

-- Written by Antoine Gara in New York

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