How Much Will Foreclosures Weigh Down Big Banks?

Bank-owned real estate in mortgage foreclosureThe country is in the grip of a home mortgage scandal, with big banks facing investigations, fines and penalties for playing fast and loose during the foreclosure process. There's no question that the banks will suffer, but will their stocks get hurt as a result?

One indication came on Oct. 18, when Citigroup (C) reported a third-quarter profit of $2.15 billion, easily beating analysts' expectations and sending the company's shares higher by 5%. That lifted all banks shares, which had lost $50 billion in valuation at the end of the previous week because of concerns about foreclosure losses.

But Citi indicated that it had managed to sidestep the problems facing banking rivals JPMorgan Chase (JPM), Bank of America (BAC) and Wells Fargo (WFC), which have announced moratoriums on foreclosures while they study whether they acted improperly in the process of documenting foreclosures prior to sales. "We believe that our overall process is sound, and our reviews indicate that nothing is amiss," says John Gerspach, Citi's chief financial officer.

The current mortgage crisis could hurt bank earnings in several possible ways, not all of them directly related to the foreclosure problem.

Investors to Banks: Take It Back

The first is what the banks have termed "putbacks," but are really repurchases of mortgages. Most banks don't keep mortgages on their books any more. Instead, they pool home loans together and sell slices of those bundled securities to investors, who assume the credit and interest rate risk on the underlying loans.

When they sell the loans, the banks make "representations and warrants" to the investors that the borrowers meet certain loan criteria, such as the level of their FICO credit scores or their income. If it turns out later that this information is wrong, the investor can force the bank to repurchase the mortgage from the trust that holds them.

JPMorgan analysts said in a report released Oct. 18 that the putback risk to the industry as a whole might be as high as $55 billion to $120 billion. They said those losses would probably be realized over a period of about five years, so the annual total might run at $10 billion to $25 billion.

Squeezing Every Penny

The JPMorgan estimate was different for loans securitized by government-controlled agencies like Fannie Mae and Freddie Mac. With Congress in an uproar about Fannie's and Freddie's losses, now estimated at $140 billion, the government will likely try to squeeze every penny out of the banks that it can, given that they're now making large profits after being bailed out by taxpayers.

The JPMorgan analysts said the agencies are likely to try to force the banks to take back about 25% of defaulted loans, with about 40% of those demands being successful.

With private sector securitization of mortgages, banks have less recourse to complain about fraud and other misstatements, so repurchases of mortgages would have only a 20% success rate, leading to an estimated 5% loss on defaulted loans.

JPMorgan itself acknowledged this last week when it released its own third-quarter earnings and disclosed that it had put aside an additional $622 million in reserves to cover losses from forced repurchases of mortgages. That didn't seem to have hurt JPMorgan's stock: It was up 2.5% on Oct. 18.

Potential Fines and Penalties

Al Savastano, banking analyst at Macquarie Securities in New York, says the repurchase problem is likely to fester for years and that it's hard to know how much each bank faces in losses. "We think it's going to be an earnings issue, not a capital issue," Savastano says. 'We are a lot more comfortable trying to estimate credit losses than this."

The other potential cost to banks comes from losses the banks suffer because of their actions in the foreclosure crisis. Treasury Secretary Timothy Geithner said last week that the Obama administration opposes any national moratorium on foreclosures, so losses caused by not being able to sell foreclosed homes are likely to be limited in the short term.

"We believe that the big banks have the capacity to withstand potential setbacks from the foreclosure moratoriums and related issues as they currently stand, and we believe these issues should ultimately prove manageable in the context of large bank franchises," say CreditSights research analysts.

Based on a potential fine of $25,000 for each false affidavit filed -- the banks have to attest that they reviewed each loan file, but in many cases, they didn't -- CreditSIghts estimates JPMorgan could face $2 billion to $3 billion in fines, which could possibly be settled for $500 million to $1 billion. The CreditSights analysts say BofA and Wells Fargo also might face a similar amount.

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I personally think that bankruptcy is much better than foreclosure. You seem to bounce back from bankruptcy a lot faster now days. They have secured credit cards and all kinds of ways to rebuild you credit. But foreclosure is more like an event that even with recovered credit, could keep you from buying another home.

July 23 2013 at 1:57 PM Report abuse rate up rate down Reply

only fair? owning a home isnt a right

October 19 2010 at 10:35 PM Report abuse +1 rate up rate down Reply

Tent Cities. The shocking reality from the Trickle Down era in America. Foreclosed office buildings would make conversion condos for those forclosed out of houses / only fair -- cool satellite view of earth; Balkingpoints / www

October 19 2010 at 3:15 PM Report abuse +1 rate up rate down Reply

this mess is a simple matter of law. these documents need to read, authenticated, notorized and signed. ITS THE LAW. they cannot do this because the paperwork is nowhere to be found due to mergers layoffs and mortgages being thrown into pools for stock offerings, so they creat new ones thats called FORGERY a serious federal criminal CRIME. processing the these documents WITHOUT DUE DILIGENCE over and over again os FRAUD. these crimes are being commited over and over again. why? because banks have laid off so many people, most of them on the clerical end. they are more concerned with sales and less concerned with bonifying and qualifying what they are doing. how do you fix it simple HIRE PEOPLE TO PROCESS THE PAPERWORK PROPERLY. they take tarp, fire people and break the law on the wholesale level. these large corperations contiually merger and fire multitudes of jobs so they can show a profit for share holders. the actual product they push suffers in the end

October 19 2010 at 2:09 PM Report abuse +1 rate up rate down Reply

Maybe 9/11 was a bigger con it is damn close how ever..Ehhhh

October 19 2010 at 1:27 PM Report abuse +1 rate up rate down Reply

Deregulation was a pyramid scheme where the banks sold off our mortgages to the people at the bottom of the pyramid guaranteeing it with our tax dollars. The biggest con in American history happened in 1999.

October 19 2010 at 1:26 PM Report abuse +2 rate up rate down Reply

The glut of upper end housing banks have on the books assessed at 2007 values will drop once they put these houses on the market in 2011. Their losses will mount up again. They know not what the result will be. They have forgotten about we the people and the power we have as a people. The rampant spending with no accountability will end with a POP !.

October 19 2010 at 1:24 PM Report abuse +1 rate up rate down Reply

More and more people will want to come to this country from the EU and else where once they get fed up with the way things are deteriating in places over there. The rich will pack up and come here. It is just a matter of time. The real threat from the housing crisis is deflation in housing. The fact that our spending power is drying up. This means we are living from pay check to paycheck with not much extra for the economy to grow with. Which is good for the few young wanting to buy a home and bad for the old that must retire with less. On the flip side what goes down will go up again after it goes down and bounces back up. Conserve and cut back what you buy.

October 19 2010 at 1:16 PM Report abuse +1 rate up rate down Reply

well my son tried to buy a foreclosed home...he had a contract and a date to close and the Bank of America kept extending the closing ..I believe it started on August 31st and the last extension was October seems there were issues with the a/c that had to be addressed and an electrical instead of just telling my son that they wouldn't fix it or discuss with him a way to amend this...they kept extending hoping that my son would back out of the deal..and he did after waiting three months to close..then they put the house back on the market at $8,000 if thats no under-handed I don't know what is...

October 19 2010 at 1:00 PM Report abuse +1 rate up rate down Reply

Freddie Mac and Fannie Mae should be eliminated as federal government sponsored enterprises. Mortgage, banking, and acting as an intermediary on mortgages, lending, etc. should cease. These institutions have been riddled with corruption, political paybacks, executive pay scandals, and more...and they are one of the prime reasons behind the current failure of our economy. Banking, lending, and mortgage functions should be private, not government controlled. Cut out the cancer. The Community Reinvestment Act should be repealed. The federal government should set up guidelines (not control) for responsible lending under affordable conditions, not those destined for sure failure. WORKING low income people and those in need should have access to lower interest rate loans, but still within the realm of their affordability to repay these loans. In other words, don't lower the standards where people will obviously default due to lack of affordability, lower interest rates should still maintain the financial integrity of the lending institutions, as well as limiting such loans where they are the exception, not the rule.

October 19 2010 at 12:32 PM Report abuse +3 rate up rate down Reply