Wells Fargo: Financial Winners & Losers

Financial stocks were trending downward on indications that bad mortgage may rise.
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NEW YORK (

TheStreet

) -- Financial stocks were trending downward on Thursday, on indications that the cost of bad mortgage debt may rise in coming quarters.

The KBW Bank Index was down 1.1% at 45.70, and big banks were losing more steam as their potential exposure to mortgage troubles became a concern. By late morning,

Wells Fargo

(WFC) - Get Report

had fallen 1.9% to $24.91;

JPMorgan Chase

(JPM) - Get Report

had dropped 1% to $37.51;

Bank of America

(BAC) - Get Report

was down 0.9% at $13.20;

Citigroup

(C) - Get Report

was shedding 0.8% to $3.83;

Goldman Sachs

(GS) - Get Report

was down 0.7% at $148.17; and

Morgan Stanley

(MS) - Get Report

was down 0.5% at $26.12.

The downturn in bank stocks came on the heels of reports about banks needing to repurchase billions of dollars' worth of mortgage debt they had passed along to

Fannie Mae

(FNMA.OB)

and

Freddie Mac

(FMCC.OB)

. Last week, the government-operated mortgage-finance giants indicated that they'd be pushing more loans back to the banking industry due to bad underwriting or document errors.

In a report on Wednesday, Fitch Ratings estimated that the four largest banks - Bank of America, Wells Fargo, JPMorgan Chase and Citigroup - might face anywhere from $17 billion to $42 billion in additional losses as a result, depending on how much bad debt is handed back to them successfully.

However, Fitch cautioned against reading too much into those numbers.

"These figures do not incorporate the ability to cure deficiencies in loans, thus ultimate realized losses could be lower than these figures," the ratings agency said in a press release. "To put these figures in perspective, these institutions had annualized pre-provision net revenues and net income of $390 billion and $54 billion, respectively, in aggregate and $391 billion of tangible common equity."

There are indications that Wells Fargo could be one of the hardest hit from its mortgage business for a variety of reasons.

Wells is the second-largest mortgage lender behind Bank of America, and has boosted returns in that division through

a hedging strategy that has become less profitable. Yields have narrowed as

talk has turned to deflation rather than inflation, meaning Wells would have to be very nimble to keep margins

as high as they had been in recent quarters.

Additionally, the company has been

spending a lot of money on workouts for troubled borrowers and may have a lot of loans to repurchase from Fannie and Freddie, due to Wachovia's legacy loans. Wells posted $442 million in losses on the loans it repurchased from Fannie and Freddie during the first six months of 2010.

"These loans were repurchased from both GSEs and they were originally issued between 2006 and 2008," Rochdale Securities analyst Dick Bove said in a note on Wednesday. "The problem at the moment is that it is unknown what the current risk to the bank is from these types of loans."

After facing tough questions on how the change may impact net interest margins during a second-quarter conference call on July 21, CEO John Stumpf responded thus:

"We don't run the Company around the NIM," he said. "The NIM is what it is. If we like MBS yields, and at some point in time we will, and we have huge capacity to add those, it might be negative to the NIM but be positive to net income...

but the NIM is not the goal here."

As far as the broader GSE buyback trend goes, it

started much earlier this year, with Bank of America CEO Brian Moynihan calling it "a loan-by-loan fight" in March, part of "a war that will go on for a while." But the battle appears to be getting bloodier, according to several high-profile speakers at a Treasury Department conference on Tuesday.

Lewis Ranieri, the so-called "father" of mortgage-backed securities, indicated that the federal government is pushing back loans for insignificant reasons, a practice that hasn't occurred in the past.

"You didn't put your lawyers on the docs to find out some minor breach...It's become

a game of 'pass the losses' for reps and warranties," he said, later adding: "You can't make a rep and warranty a guarantee. If there's a document deficiency, you cure the document deficiency."

Bob Ryan, former top executive of mortgage pricing at Freddie Mac who is now senior risk officer for the Federal Housing Administration, indicated agreement that buybacks are increasing at an unusual pace.

Alex Pollock , a former banker and regulator who is now a fellow at the American Enterprise Institute, called it a "rep and warranty overreaction," but said it wasn't surprising.

"We're in an absolutely normal stage of the cycle, which is

dividing up the losses," he said.

Also on Thursday, Freddie Mac said traditional 30-year fixed mortgages dropped to a fresh record low of 4.42%, down from 4.44% the previous week. Rates have been dropping steadily for the past couple of months, but

haven't been enough to woo overstretched homeowners into new purchases.

-- Written by Lauren Tara LaCapra in New York

.

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