Colin Barr

Following the money in banking, economics, and Washington

Banks face $3.7 billion foreclosure hit

October 18, 2010: 2:23 PM ET

Settling the foreclosure fiasco could set the biggest banks back a cool $3.7 billion.

So says Janney Capital Markets analyst Guy LeBas, who writes in a note to clients Monday that he continues to view the unrest over banks' mortgage missteps as a headache rather than a brewing crisis.

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But an expensive headache it will be: two banks, the giant mortgage lenders Bank of America (BAC) and JPMorgan Chase (JPM), could end up paying $1 billion each, according to LeBas' back-of-the-envelope calculation.

The No. 3 mortgage bank, Wells Fargo (WFC), is likely to pay as much as $900 million, he estimates. That's the highest cost for any major bank as a proportion of Tier 1 capital, the funds regulators insist be set aside to help a bank through a downturn.

The estimate comes as Wall Street is finally coming to grips with the scale of the banks' foreclosure follies. Bank shares have tumbled over the past week, after JPMorgan Chase CEO Jamie Dimon conceded his bank may have to pay penalties to settle legal inquiries by the 50 state attorneys general.

LeBas bases his forecasts on the case of Ally Bank, the taxpayer-owned lender that's being sued by the Ohio attorney general for $25,000 per false foreclosure affidavit. Though the bank's 46,000 foreclosures in the first half of 2010 alone suggest Ally's exposure runs to $1.15 billion, LeBas says that's probably way too high.

Realistically, only a portion of those foreclosures are problematic, and the rule of settlements suggests Ally will only end up paying 25% - 40% of their total liability, or about $250 million - $530 million for the first half of the year. Other affected lenders and servicers may end up settling for less, particularly if their foreclosure errors aren't as well-publicized as Ally's.

LeBas acknowledges that there's no way of really quantifying the exposures faced by lenders ranging from Bank of America and Wells to Fifth Third (FITB) and Capital One (COF). An investigation into the banks' missteps has only just begun, and the costs of settling probes likely won't be evenly distributed, with some banks running looser ships and having to pay more as a result.

What's more, the Janney estimates consider only legal costs, leaving alone other costly factors including:

In addition to these direct costs, there remain a range of much tougher-to-handicap expenses which have the potential to emerge from the foreclosure morass. Already, valuations of subordinated non-agency mortgage tranches are beginning to benefit from the foreclosure moratorium at the expense of senior tranches, a shift which has uncertain impact on banks' securities portfolios. In addition, the threat of a more challenging foreclosure process could permit homeowners to exercise greater leverage in requesting mortgage modifications.

But while those factors could keep the pressure on bank stocks for some time, they aren't likely to lead to a crisis, in LeBas' estimation:

While these indirect expenses could prove sizeable, the chance that they'll eat through capital cushions at the major financial institutions remains unlikely.

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About This Author
Colin Barr
Colin Barr
Senior Writer, Fortune

Colin Barr has covered finance for Fortune.com since November 2007. Previously he was a writer and editor for TheStreet.com, winning a 2006 Society of American Business Editors and Writers award for "The Five Dumbest Things on Wall Street," and for Dow Jones Newswires. He is a 1991 graduate of Penn State and lives in Port Washington, N.Y., with his wife Meena Bose and their two kids.

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