Banks face $60 billion mortgage hit: S&P

February 8, 2011, 10:48 PM UTC

Cleaning up the mortgage mess isn’t getting any cheaper.

The banking industry could find itself picking up a $60 billion tab for souring home loans, Standard & Poor’s Ratings says in its latest report on so-called mortgage putbacks.

A trend that isn't the banks' friend (source: S&P).

When S&P last looked at the issue in November, it said the six biggest U.S. lenders faced $43 billion in mortgage-repurchase costs. That was itself up from July’s estimate, which held that the leading banks would have to build their reserves to the tune of $24 billion.

S&P said the biggest banks — Bank of America (BAC), JPMorgan Chase (JPM), Wells Fargo (WFC), Citi (C), U.S. Bancorp (USB) and PNC (PNC) — will absorb the bulk of the putback costs. But the rating agency said that even the higher tab won’t threaten the banks’ capital positions or lead to ratings downgrades.

February’s estimate stems largely from rising projected costs to settle claims by private mortgage securities investors and monoline insurers.

Just over half of the latest estimate, $31 billion, comes from settling claims from the government-backed mortgage companies Fannie Mae and Freddie Mac. The banks’ duties to Fannie and Freddie are clearly defined in contracts, which gives the mortgage companies unusual leverage in pressing for the banks to take back bad loans (not that they necessarily always use it).

But S&P has been raising its forecasts for the costs of settling disputes with private investors and monoline insurers who promised to pay when borrowers fell behind. The rating agency now estimates the cost of settling those cases at $29 billion, evenly split between the two categories.

As recently as November, S&P was saying that “our analysis suggests that, for the time being, most losses are likely to come from resolving the GSE-related claims.”

Rising projected costs for settling the private label and monoline claims could hit bank earnings at a time when tighter rules and slow economic growth are already weighing on profits. What’s more, the report highlights the risk that the banks could yet take more lumps, depending on how various cases turn out and whether investors become more aggressive in pressing their grievances.

Currently, nonagency investor losses make up a small amount of banks’ existing reserves, as banks are prohibited from taking a specific reserve until losses seem probable. Some banks, though, have begun to prepare for possible put-back expense by adding to a general litigation reserve.

Even so, losses in the nonagency investor segment could increase significantly and outstrip these general reserves. Indeed, successful early nonagency lawsuits could embolden other investors to gather and bring forth lawsuits in an attempt to force banks to buy back underperforming mortgages. For now, though, we have made what we believe to be reasonable nonagency investor put-back assumptions.

Bank of America, the bank with the biggest bad loan problem, raised some eyebrows last month when it said it expected the cost of settling private label cases might top out at between $7 billion and $10 billion, even as it said that the lack of claims experience in those cases prevented it from taking reserves now against those losses.