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Banks Face Mortgage Scrutiny as $49 Billion in Value Vanishes

Citigroup Inc., Bank of America Corp. and Wells Fargo & Co., set to report earnings this week, face investors groping for answers after evidence of flawed foreclosure documents triggered a selloff of U.S. bank stocks.

The banks plus JPMorgan Chase & Co. saw $49.3 billion in market value shaved off in the three days ended Oct. 15 amid concern that rising costs of faulty foreclosures will eat into profits. JPMorgan set aside $2.3 billion of reserves to cover mortgage repurchases or litigation expenses, including some for “mortgage-related matters,” the lender said Oct. 13.

“We’ve had two banks report good earnings in terms of credit-quality costs coming down,” said Erik Oja, an equity analyst at Standard & Poor’s in New York, referring to JPMorgan and First Horizon National Corp. “But people don’t care. They say ‘Well, how many foreclosures do you have in the pipeline? And what are you seeing?’ And they answer that we’re looking at each one. And people say ‘All right, sell.’”

An investigation by attorneys general in all 50 states into foreclosure practices has fueled speculation that banks will have to purchase billions of dollars in loans from mortgage-bond investors who will challenge the paperwork. Lenders have suspended foreclosures in some states and started reviews after court documents surfaced showing employees at several large mortgage firms signed papers without ensuring their accuracy.

Oja cut his recommendation on Charlotte, North Carolina- based Bank of America to “hold” from “strong buy” on Oct. 15 because of uncertainty about mortgage costs.

Dimon’s ‘Blip’

JPMorgan Chief Executive Officer Jamie Dimon, 54, faced analysts’ questions about foreclosures on the company’s third- quarter conference call Oct. 13. Dimon said the New York-based lender probably will pay an “incremental” sum to review and fix foreclosure documents.

“If you’re talking about three or four weeks, it will be a blip in the housing market,” Dimon told investors. “If it went on for a long period of time, it will have a lot of consequences, most of which will be adverse on everybody.”

Analysts differ in their cost estimates. Compass Point Research and Trading LLC’s Chris Gamaitoni estimated in August that lenders may suffer as much as $179.2 billion in losses tied to soured mortgages they will be forced to repurchase from mortgage-bond insurers and investors. Last week, Mike Mayo, an analyst at Credit Agricole Securities USA in New York, estimated a cost of $20 billion for repurchases when including government- sponsored entities Fannie Mae and Freddie Mac. Goldman Sachs Group Inc.’s Richard Ramsden said a worst-case scenario would be $84 billion, while Paul Miller, an analyst at FBR Capital Markets in Arlington, Virginia, said it could cost the banks as much as $91 billion.

‘A Lot of Uncertainty’

“There’s a lot of uncertainty surrounding what the eventual cost of mortgage repurchases will be,” Deutsche Bank AG analysts led by Matthew O’Connor wrote in a note last week. “The bad news is we (and the banks) won’t know the answer for some time. The good news is the banks should have time to absorb the losses.”

Bank of America, JPMorgan and Wells Fargo have the most at stake, O’Connor wrote.

Citigroup today said third-quarter profit rose to $2.17 billion, beating analyst estimates, as it reduced loan-loss reserves. The New York-based bank set aside $322 million to repurchase mortgages, compared with $347 million in the second quarter. Bank of America, which has halted foreclosure sales in 50 states, is scheduled to report third-quarter results tomorrow, and San Francisco-based Wells Fargo will announce results Oct. 20.

‘Messy Process’

The four banks control more than 55 percent of the market for billing and collections on U.S. home loans, according to Barclays Capital Inc. When borrowers default, the firms handle the foreclosure process.

Wells Fargo, which said it is proceeding with foreclosures, may have litigation and repurchase expenses of $15 billion over the next four years, according to Anthony Polini, a banking analyst at Raymond James & Associates Inc.

“Litigation expenses are going to be high,” Polini said in a phone interview. “Foreclosures are a messy process and one that will provide a headwind to earnings, but it doesn’t mean this recovery is postponed. It just means it happens at a slower pace.”

‘Grossly Distorted’

Barbara Desoer, 57, head of home lending at Bank of America, said Oct. 15 that estimates of added costs from foreclosures have been “grossly distorted.” The bank, the largest in the U.S. by assets, stands by the accuracy of its process, she said in an interview.

Mark C. Rodgers, a spokesman for Citigroup, said in an e- mailed statement last week that the bank has safeguards in place to prevent improper filings. Wells Fargo has enacted an additional review of pending foreclosures in 23 states to provide “further assurance” that information is correct, a spokeswoman, Vickee Adams, said last week.

Bank of America dropped $1.54, or 11.4 percent, in the three days ended Oct. 15, while Citigroup fell 29 cents, or 6.8 percent, the biggest three-day drop for the stocks since July. Wells Fargo declined $2.39, or 9.2 percent, the largest such falloff since May. JPMorgan fell $3.25, or 8 percent, over the same three days, the worst such period since the three days ended Jan. 22.

The market value of the 24 lenders in the KBW Bank Index fell by a combined $58.5 billion in the three days, according to data compiled by Bloomberg.

“People are trying to sort out who’s going to bear the costs,” said James Barth, a professor of finance at Auburn University in Alabama and senior finance fellow at the Milken Institute in Santa Monica, California. “Someone has to pay for this, and that’s going to be the lenders.”

To contact the reporter on this story: Dakin Campbell in San Francisco at dcampbell27@bloomberg.net

To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net

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