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Foreclosure Crisis: Home Equity Loan Time Bomb

Wells Fargo, Bank of America, JPMorgan Chase and Citigroup could face $23.5 billion in costs from the foreclosure crisis, with most costs coming from home-equity loans.



) -- 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

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has the most exposure to home-equity costs, at $7.8 billion.

JPMorgan Chase

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is right behind with $7.2 billion, followed by

Bank of America

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at $4.9 billion and


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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



Freddie Mac


. 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.

>>>Feds May Sue Banks Over Buybacks

Last quarter, JPMorgan added another $1 billion to its repurchase reserves, even as the firm-wide reserves declined, adding a buffer to earnings. CFO Doug Braunstein chalked the increase up to "the continuation of the high level of requests for loan files in the GSEs as well as repurchase demands."

CreditSights believes Bank of America has the biggest exposure to so-called "reps & warranties" requests, at $3.5 billion. It estimates Wells Fargo's exposure as second-highest, at $2.7 billion, with JPMorgan at $956 million and Citi at $372 million. While the figures are nothing to sneeze at, CreditSights helped to discredit a questionable report by a hedge fund last week, which estimated that Bank of America might face over $70 billion in buyback requests.

However, it's worth noting that CreditSights used some quick, back-of-the-envelope calculations to come up with its settlement estimates.

At the crux of its figures is a lawsuit by Ohio Attorney General Richard Cordray against GMAC, seeking $25,000 for each foreclosure document processed improperly in his state, along with undefined restitution to consumers. JPMorgan alone is examining 115,000 filings; Bank of America is examining 102,000.

CreditSights points out that the maximum hit for JPMorgan or BofA would be $2 billion to $3 billion. The debt-research firm thinks settlements are likely to be much lower, in the ballpark of $500 million to $1 billion for those two banks and Wells Fargo and just $200 million to $600 million for Citi.

After Cordray filed suit, all 50 attorneys general banded together to investigate the practices of major mortgage servicers. It's unclear what the outcome of that nationwide scrutiny will be. Yet it seems clear that the the "robosigning" scandal - in which employees scribbled their "John Hancocks" on foreclosure paperwork without properly vetting the information - may be just the tip of the iceberg in terms of cost for big banks.

CreditSights characterized the potential expense of less than $1 billion apiece as "manageable," given their annual earnings. Citigroup, for instance, reported $2.2 billion in profit for the third quarter alone. JPMorgan earned $4.4 billion and the other two banks will report earnings later this week.

-- Written by Lauren Tara LaCapra in New York


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