Fitch: BAC’s Settlement With Department of Justice Neutral to Ratings

Fitch Ratings believes the settlement between Bank of America Corporation (BAC) and the Department of Justice (DOJ) on behalf of several governmental entities and State Attorneys General is largely neutral to BAC’s ratings (rated ‘A’/’F1’/’a-‘ with a Negative Outlook by Fitch) at this point.

Terms of the nearly $17 billion settlement include a $5.02 billion cash penalty, $4.63 billion in cash restitution, and $7 billion in consumer relief. The incremental quarterly cost of this agreement is $5.3 pre-tax, as reserves had been built previously. This is a sizable cost both on an accounting and a cash basis, and Fitch believes this will likely cause BAC to post a net loss in 3Q’14 though capital ratios should remain relatively flat.

BAC’s Long-term IDR is driven by Fitch’s view that there remains an extremely high probability of support from the U.S. government if required. The Negative Outlook reflects the agency’s expectation that this probability is likely to decline within one to two years given the Dodd Frank Act and progress regulators have made on implementing the Orderly Liquidation Authority. As a result and all else being equal, Fitch expects to downgrade the Long-term IDR to the level of the Viability Rating (VR), rated ‘a-‘, by 1H15.

This settlement combined with BAC’s other mortgage related settlements, litigation costs, and charges over the last several years pushes BAC’s overall consideration in these various legal matters to the higher end of some of Fitch’s internal estimates of total mortgage and legal related exposure that were compiled in the 2009/2010 time frame. Depending on what expenses, charges, and/or settlements are included in BAC’s overall litigation costs, the cumulative total costs and losses related to litigation and losses is likely north of $60 billion.

To the extent that other unforeseen or incremental large settlements or litigation costs arise such that they continue to absorb earnings generation and/or constrain capital accumulation, there could be negative pressure on the company’s VR and eventually on its IDRs.

Alternatively, to the extent that this settlement with the DOJ largely resolves much of BAC’s legacy exposures and on-going litigation, and allows management to focus more of its efforts on running and improving BAC’s core businesses, this could have longer-term positive rating implications.

As stated in prior rating commentary, these implications would be predicated on management’s ability to execute on continued efficiency initiatives without the overhang of persistent settlements and litigation costs and to drive new business across the franchise. This should drive better earnings performance, and combined with higher short-term interest rates at some point thereby allow for the incremental build of retained earnings to continue to enhance the company’s capital position over a longer-term time horizon.

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