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In an attempt to remove the vestiges of the financial crisis, Bank of America Corporation (BAC - Analyst Report) announced a comprehensive plan to settle its legal dispute with MBIA Inc. . The 5-year-old legal dispute involved conflict over guarantees on commercial mortgage-backed securities (CMBS).
Terms of the Agreement
Under the terms of the agreement, BofA will pay nearly $1.6 billion in cash and give back $137 million worth of MBIA 5.70% senior notes (acquired through a tender offer in Dec 2012) maturing in 2034 to MBIA. Further, the company will provide a senior secured credit facility worth $500 million to MBIA Insurance Corp, MBIA’s structured finance division.
Notably, BofA will get warrants to buy 9.94 million of MBIA shares at an exercise price of $9.59 per share. This represents approximately 4.9% of MBIA’s current shares outstanding. Moreover, these warrants have to be exercised prior to May 2018.
Further, BofA will close the outstanding credit default swap (CDS) protection deal, which was purchased from MBIA on CMBS. In addition to that, all the pending litigations between the 2 parties will be resolved.
The agreement also states that BofA will pull out from the lawsuits challenging MBIA’s restructuring. Similarly, MBIA has agreed to withdraw charges against BofA related to the quality of bonds underlying the guarantees on CMBS.
The agreement requires certain approvals from the New York State Department of Financial Services, which are expected to be received soon, following which all the terms of the deal will be executed. Moreover, The Blackstone Group (BX - Analyst Report) acted as a financial advisor to MBIA in relation to the settlement deal.
Impact on BofA’s 1Q Earnings
As BofA has still not filed its quarterly report for the period ended Mar 31, 2013, with the Securities and Exchange Commission (SEC), these settlement charges will be adjusted with its first-quarter results. The settlement charges will lower the company’s earnings, while leading to an improvement of its capital ratios.
As a result of the settlement agreement, the litigation charge will lower BofA’s first-quarter net income to $1.5 billion or 10 cents per share. On Apr 17, while announcing the first-quarter results, the company reported net income of $2.6 billion or 20 cents per share.
Notably, BofA’s estimated Tier 1 common capital ratio under Basel III as of Mar 31, 2013, rose by 10 basis points to 9.52%. This reflects reduction in risk-weighted assets (RWAs) related to the terminated CDS contracts, partially offset by extra litigation costs.
Still a Long Way to Go
For MBIA, the settlement will do away with many obligations to guarantee regular principal and interest payments on commercial real estate related bonds, which could again default under the current economic scenario. The deal also clears the big hindrance that lay in its way of restructuring.
For BofA, the settlement agreement is another positive step in resolving its legal and legacy issues. The company has been facing many lawsuits, some of which are related to the sale of mortgage backed securities by Countrywide Financial – acquired in 2008.
In Jan 2013, BofA announced nearly $11.6 billion worth of settlement with Fannie Mae (FNMA) to end its mortgage related problems. Further, in 2011, the company had reached an $8.5 billion settlement deal with the private investors who had brought those risky MBS.
We believe that the settlement deal will go a long way to improve BofA’s overall efficiency. The company has been striving hard to regain its past glory. For this, it has announced several initiatives that are now bearing fruit. All the initiatives will lead to enhanced financial performance going forward.
Currently, BofA carries a Zacks Rank #3 (Hold).