Banks' Worst Fear for 2012

NEW YORK ( TheStreet) -There are so many threats to the largest U.S. banks it can be dizzying trying to keep up with it all.

Analysts have been saying for months that bank stocks are at historic low valuations, and yet lower still they go. Before the 2008 crisis, trading below book value was considered to be absurdly cheap, but now we have even industry leaders like JPMorgan Chase ( JPM) and Goldman Sachs ( GS) trading well below book, and industry laggard Bank of America ( BAC) trading at a quarter of book value.
New York Attorney General Eric Schneiderman

The issue for Bank of America is its massive exposure to troubled mortgages, but following a detailed analysis of those risks that added up to more than 50 pages, Citigroup analyst Keith Horowitz concluded that even if the bank is under-reserved by $32 billion--a worst case in his view-- "when you factor in the earnings power and the time it will take to resolve these issues it appears to be manageable."

But there is a far, far worse case than that, according to Paul Miller, analyst at FBR Capital Markets.

"The real problem is up in New York, what Schneiderman's doing," says Miller, referring to New York Attorney General Eric Schneiderman. "He is saying that the securitization process itself is corrupt and the securities were not legal entities. So then you wake up one day and I'm a bank--let's just use Bank of America, for example--that issued $1 trillion over its life of non-agency securities, and they're all done wrong."

Schneiderman, along with Attorneys General from Delaware and Massachussetts, has refused to go along with their counterparts in other states in agreeing to an estimated $20-25 billion settlement with banks including Bank of America, JPMorgan Chase, Citigroup, and Wells Fargo over mortgage servicing issues.

They refused, according to an essay published in Politico by Schneiderman and Delaware Attorney General Beau Biden in November, because, as part of the proposed settlement "the financial institutions on the other side of the negotiating table have predictably sought releases that are as broad as possible from future liabilities."

Biden and Schneiderman resist such a deal because they have other mortgage-related investigations pending, including the one into the mortgage securitization process itself.

Schneiderman has said little about his investigation, though The Huffington Post reported last year that Bank of America is a target, and that Schneiderman has also sought documents from Goldman Sachs and Morgan Stanley.

A legal victory in that case--assuming one is eventually brought--would lower the bar significantly for private litigation, Miller says.

"If he wins and they're fraudulent you could see the banks having to buy all this stuff back, or would they just negotiate some big deal?" Miller wonders aloud.

And how much would such a deal cost the banks?

"That number is so big I don't even want to think of it," Miller says.

A Nov. 14 editorial in The New York Times states that Schneiderman and other "rebel attorneys general want the banks to hand over more than $200 billion, which would enable the government to write down tens of millions of mortgages." The editorial, which is republished on Schneiderman's website, does not say where that figure came from. A Schneiderman spokesman declined to discuss details of the investigation.

But that $200 billion figure--assuming it is in fact what Schneiderman and the others are seeking --would not take into account private litigation, nor what would presumably be sweeping reforms in the mortgage business going forward, potentially taking a bite out of future bank profits.

As far as U.S. banks are concerned, even the threat of a Eurozone breakup may look tame alongside New York State's Attorney General.

-- Written by Dan Freed in New York.

Readers Also Like:


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

More from Stocks

Stocks Extend Gains Amid Progress on U.S.-China Trade

Stocks Extend Gains Amid Progress on U.S.-China Trade

Red Hot Micron Is Still One Heck of a Bargain

Red Hot Micron Is Still One Heck of a Bargain

Stacey Cunningham: From Intern to Head of the New York Stock Exchange

Stacey Cunningham: From Intern to Head of the New York Stock Exchange

China Gives Tesla, Ford, General Motors and Trump One Awesome Present

China Gives Tesla, Ford, General Motors and Trump One Awesome Present

Oil Prices, China Tariffs, Micron and Kohl's - 5 Things You Must Know

Oil Prices, China Tariffs, Micron and Kohl's - 5 Things You Must Know