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Big Banks May Still Face $50B-Plus Legal Tab on Mortgages

NEW YORK (TheStreet) -- Global investment banks still underestimate litigation risk and are likely to face another $50 billion to $70 billion in mortgage-related fines and settlement costs, according to a report published Monday by UBS.

"Those banks that quantify litigation risk do so at a modest 2-4% of market capitalization. However this quantification only captures litigation risk that is both reasonably possible and estimable (banks expense all litigation that is both probable and estimable) and we think it understates the risk to shareholders," wrote a team of six UBS analysts based in New York, London and Zurich. Their own estimate "incorporates a more severe downside" including a roughly 5% hit to the earnings over the next five quarters and an approximately 6% hit to valuation, the report states.

The UBS analysts argue LIBOR-related fines are largely in the rear view mirror, though they concede at the same time class-action risk tied to LIBOR is "harder to quantify." On the other hand, the mortgage-related risks remain, they argue. They see Bank of America (BAC - Get Report) and Royal Bank of Scotland Group (RBS - Get Report) as most exposed on this front. However, while they believe Bank of America has "provided for a large portion of potential litigation risk, the same is not true for RBS, which is at an early stage of the judicial process."

UBS's analysts also cite a report from the London School of Economics, which contends banks have paid about $235 billion, or 20% of the market cap, between 2008-2012 tied to misconduct. That number may be light, UBS's analysts argue, since they note it leaves out some key players, the most notable of which is Deutsche Bank (DB).

Despite the big legal headaches, UBS's analysts see global investment banks as undervalued.

"We see global investment banks trading on 1.1x tangible book value for an expected 11% return in 2014. Current valuation suggests the market is treating 2014 returns as normal -- whereas we expect a higher level of sustainable returns, in time," UBS's analysts write. They see Credit Suisse (CS) as the stand out pick on a valuation basis, though they also maintain "buy" ratings on Citigroup (C), Deutsche Bank, JPMorgan Chase (JPM) and Morgan Stanley (MS).

The large U.S. banks were slightly higher in sync with the broader market Monday. About 30 minutes before the close, Bank of America was up 0.40% to $15,24, Citigroup was up .01% to $50.97. U.S. listed shares of the big European banks were faring better, with Deutsche Bank up 1.74% to $46.32, RBS up 0.97% to $10.45 and Credit Suisse up 1.33% to $29.70.

-- Written by Dan Freed in New York

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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