JPMorgan has pledged to comprehensively review more than 115,000 loans that are in the foreclosure process and has legal reserves of $4.3 billion, Wells Fargo is expected to follow suit. Bank of America Corp Chief Executive Brian Moynihan is quoted by Reuters as saying he is "not so concerned" that an ongoing review of foreclosure documents will delay a rebound in the U.S. housing market. HSBC believe (i) they have been at the forefront of helping people manage their debt problems and avoiding foreclosure during the wind-down of their Household franchise and (ii) if they are stopped from foreclosing the impact is just a carry cost of the funding while they get the processes right before re-starting foreclosures. HSBC had $205mm reserve at H1 for broker-channel originated mortgages. Applying JPM's increase implies an additional $100mm charge (ie. not even a rounding error). Of course, public sentiment is hostile – fuelled by the press and a hedge-fund report which speculated Bank of America alone could face as much as $59 billion in losses ( in lieu of its purchase of Countrywide, the former largest mortgage provider, as a going concern) – several analysts have since strongly refuted such numbers. Barclays Capital believe that the improper completion of paperwork might result in repurchase requests, industry-wide, that could cost of up to $22 billion – which suggests the reserves already taken by JP Morgan are sufficient. Furthermore, according to JPMorgan, realized losses related to repurchases appear to be peaking and it expects a 50% decline in 2011 (from an estimated $2.0 billion in 2010).
The originators of such mortgages do have fiduciary responsibilities which clearly have been treated too lightly – for which penalties will result – but a related issue concerns the inclusion of mortgages in securitization pools, despite rejections by independent appraisers, which could open those deals for repurchases and further delay the return of a properly functioning securitization market.
However, in our view, ultimately neither issue looks to have a material impact on the franchise strengths of the larger banks ( although the ‘tail’ of this risk will likely last longest with Bank of America). Across JP Morgan, Wells Fargo and Bank of America the impact is expected to be probably no more than a 4%, 5% and 8% drag on respective earnings over the next 3-4 years. Some of these banks and title insurers may be guilty of sloppy paperwork but the spirit of the law is still strongly on the industry’s side. If a homeowner is not making payments on his / her mortgage then they will be foreclosed upon. Therefore unless cases emerge of families being incorrectly evicted from homes, then it seems US politics will seek to re-engage foreclosures as quickly as possible as part of the remedial process necessary to ultimately return the housing market ( and so new mortgage originations) to better health. We believe the issue could be defused over several weeks (rather than several quarters), and JPMorgan's 3Q10 conference call eased some of our concerns and comments from the other large players will be forthcoming this week.
