Bank of America (NYSE:BAC) recently reached a settlement with the Department of Justice, the SEC and some states for a cool $16.65 billion -- which settle allegations that the bank had misled investors by misrepresenting the quality of their mortgage-backed securities.
The cash payment is $9.65 billion, with another $7 billion in the form of help to consumers for modify mortgages which are now currently underwater. That puts Bank of America's total settlement to nearly $75 billion, which is much higher than the other large settlements of $27 billion from JP Morgan Chase, $12 billion from Citigroup and $10 billion from Wells Fargo.
Assuming that the worst is behind us, Bank of America can now focus on becoming a more profitable bank. However, there's is likely some overhang from investors given the sizable settlement. Even still, investors have been rewarded nicely over the last three years thanks to Bank of America's steadily rising stock price.
Has justice been done?
The settlement is less punitive than it appears, where a substantial part of it is not in the form of cash. Very little of the cash is likely to find its way to compensate investors who lost money on the mortgage-backed securities. Moreover, none of the cash will go to states like Florida and Nevada which was the hardest hit by the sub-prime crisis and where house prices are still some 30% lower than the peak.
Instead, New York will receive $300 million because it has been more aggressive in chasing mortgage damages against the big banks. Some other states such as California and Illinois will also receive cash payments.
Warren Buffett: The Bank of America bull
Legendary investor Warren Buffett believes that Bank of America will start to generate major profits after settling legal battles. Battles that have sidetracked resources and distracted the attention of management.
Assuming the major legal issues are resolved, investors can invest on the underlying business fundamentals, which means a more justified valuation for Bank of America. Net income is expected to jump to $17 billion in the next year, which is the best growth since 2006 and compares with the $11.4 billion generated in 2013.
This won't be enough to outshine the largest bank in the U.S., JPMorgan Chase (NYSE:JPM), or the most profitable, Wells Fargo (NYSE:WFC), but should be enough to satisfy value focused investors in the banking space. Buffett inspired some confidence in the bank back in 2011 with a $5 billion investment, makes his firm the largest investor in the company with a paper profit of $6.3 billion to date.
The bank has just taken the first step to rewarding investors by increasing the dividend with the approval of regulators to $0.05 a share. The amount isn't huge but it is a 400% increase. The stock trades at just 80% of book value, but the likes of JPMorgan trades at 110%. Bank of America still looks to be one of the most enticing stocks in the banking sector that are still undervalued.