Bank of America Takes Another Mortgage Hit

The bad news for Bank of America (BAC) is mortgages cost the bank $20 billion in the second quarter.

The worse news is that management continues to struggle over the ultimate cost of its mortgage operations.

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The mortgage-related costs were announced June 29, including a proposed $8.5 billion settlement with 22 institutions that bought mortgage backed securities (MBS) from Bank of America backed by mortgages that were fraudulent or otherwise didn't meet the underwriting criteria promised to the investors who bought the MBS.

Bank of America CEO Brian Moynihan

With the agreement and other mortgage-related actions taken in the second quarter of 2011, the company believes it has recorded reserves in its financial statements for a substantial portion of its representations and warranties exposure as measured by original principal balance.

Bank of America recorded a loss of 90 cents for the second quarter, equal to Thomson Reuters consensus analyst estimates.

Even following an $8.5 billion settlement with a group of 22 institutions over mortgage backed securities and $12 billion in other mortgage-related charges, there appears to be a fair amount of uncertainty among investors and analysts about the extent of the bank's ongoing exposure.

What appears certain is that the bank is well behind rivals including Citigroup (C), Wells Fargo (WFC), and JPMorgan Chase (JPM) when it comes to reserving against higher capital requirements for globally systemically important financial institutions under international regulatory guidelines known as Basel III.

Still, Bank of America has said it expects to generate enough capital out of earnings to be able to meet the requirements, which, although they don't go into effect for several years, have in recent weeks been a keen area of focus for investors and analysts.

Bank of America CFO Bruce Thompson told analysts in a June 29 conference call the bank has set aside "the lion's share of what we can," for disputes with "monoline" bond insurers, such as Assured Guarantee Ltd. (AGO) and MBIA (MBI) as well as "private label" investors in its mortgage backed securities (MBS)--those other than government sponsored entities (GSEs) Fannie Mae and Freddie Mac.

Bank of America also said the "range of possible loss" for non-GSE MBS claims is $5 billion.

While Bank of America has announced settlements with the GSEs, they are limited in scope. Also to be determined is the much-anticipated deal with a host of federal and state regulators over mortgage servicing. Some estimates have predicted a settlement of mortgage could cost Bank of America and other servicers as much as $25 billion, though many banking industry watchers, such as Sandler O'Neill analyst Jeff Harte, have said in the past, that banks would be very unlikely to agree to such a large number.

Regardless of the size of the eventual settlement, it is safe to assume Bank of America would be forced to assume responsibility for an outsized portion of it. That's because Countrywide Financial, which Bank of America acquired in 2008, was unusually aggressive in underwriting mortgages than eventually went bad.

Bank of America's potential loss exposure to mortgage-related issues in large part depends on what happens in the housing market going forward. Bank of America's Thompson said on the June 29 call that the second quarter earnings call would include greater details on how Bank of America would be impacted under different scenarios for home prices.