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Foreclosure Crisis: Home Equity Loan Time Bomb

NEW YORK ( TheStreet) -- The biggest cost ahead for large mortgage servicers may not be "robosigning" settlements or buying back bad debt - it's the follow-on mortgage products like home-equity loans that take longer to go sour.

A report on Monday by CreditSights is the latest sign that the biggest cost to banks from the mortgage crisis could be home-equity loans - whose credit-card-like aspects tend to keep borrowers current long after they've maxed out the first mortgage.

CreditSights estimates that Wells Fargo (WFC - Get Report) has the most exposure to home-equity costs, at $7.8 billion. JPMorgan Chase (JPM - Get Report) is right behind with $7.2 billion, followed by Bank of America (BAC - Get Report) at $4.9 billion and Citigroup (C - Get Report) at $3.6 billion. However, the expected lag in performance has allowed big servicers to prepare for the coming HELOC write-offs.

"Home equity will lag because home equity, by its nature, we find lags the underlying prime and the underlying real estate and lags more than most other things," JPMorgan CEO Jamie Dimon explained in an earnings call last week. "We try to account for that in our reserving."

There's been plenty of speculation regarding potential costs of the foreclosure crisis for big banks. Potential litigation from state attorneys general, homeowners and investors - along with buyback requests from purchasers of mortgage securities - has left room for optimists to shrug off the potential costs as immaterial pessimists to predict doomsday scenarios.

CreditSights examined all the potential costs that big banks face from the foreclosure crisis - settlements, home-equity write-offs and repurchase demands by mortgage finance giants Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB). It estimates the total cost for the top-four mortgage servicers - BofA, JPMorgan, Wells Fargo and Citigroup - will be $23.5 billion. Roughly 71% of that cost would come from the home-equity portfolios.

Wells Fargo will be the hardest hit for overall costs of the foreclosure crisis, using CreditSights' figures, with an $11.2 billion, or $2.13 per share, reduction of earnings on an annualized basis. Bank of America has the second-highest exposure, at $9 billion, or 90 cents per share, followed by JPMorgan at $8.8 billion, or $2.24 per share. Citi's much-smaller mortgage servicing division would face costs of $4.2 billion, or 14 cents per share.

Although Wells Fargo has the biggest apparent exposure to the foreclosure crisis, it's also been the most aggressive in responding to accusations that its processes are flawed. Unlike its peers, Wells has refused to implement any kind of moratorium on foreclosures and said its "affidavit procedures and daily auditing demonstrate that our foreclosure affidavits are accurate."

In terms of costs, so-called "reps & warranties" demands also seem to be more notable than potential "robosigning" settlements.

Fannie and Freddie have scrutinized origination documents for errors as losses continue to pile up on mortgage debt. When documents are found to have errors, those government-sponsored enterprises (GSEs) ask banks to repurchase the debt, citing representations and warranties of purchase contracts. As of mid-September, the Federal Housing Finance Agency was requesting banks buy back $20 billion in mortgage securities; about $4.7 billion of those requests hadn't been accepted.
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