Mortgage Settlement Is Credit Negative for Big US Banks

Mortgage Settlement Is Credit Negative for Big US Banks

Last Thursday, the US government and 49 state attorneys general2 reached a $25 billion agreement with the country’s five largest mortgage servicers to address faulty mortgage loan servicing and foreclosure practices. The settlement is credit negative owing to the size of the agreement. In addition, US banks remain exposed to a host of other mortgage-related issues such as continued high loan-loss provisions, repurchase costs related to bad mortgages sold to the government-sponsored enterprises (GSEs), and potential claims related to private or class action lawsuits.

The servicers that are part of the settlement include Bank of America Corporation (A2 negative; C-/Baa2 stable),3 Wells Fargo & Company (Aa3 negative; C+/A2 stable), JPMorgan Chase & Co. (Aa1 negative; B/Aa3 negative), Citigroup Inc. (A3 negative; C-/Baa1 stable), and Ally Financial Inc. (B1 stable).

The settlement was within our expectations, and those of the banks, in that their existing litigation and loan-loss reserves mostly cover the related costs. Consequently, the settlement will have little to no financial effect on the banks, outside of a modest reduction in interest income over the life of any modified loans. However, the settlement is narrower than what was originally contemplated when first proposed over a year ago. That original settlement would have resolved more legal liability for the banks related to their mortgage activities and would have allowed for principal reduction on mortgages guaranteed by the GSEs. The absence of these provisions is credit negative.

As the exhibit below shows, the settlement requires the five banks to make a combined $5 billion in cash payments to the states and federal government and to commit to a combined $20 billion in direct borrower relief, including:
» At least $10 billion for principal reductions for underwater borrowers who are delinquent or close to defaulting
» At least $3 billion to refinance mortgages for underwater borrowers who are current
» Up to $7 billion for other forms of relief, including forbearance of principal for unemployed borrowers

The agreement also requires the firms to implement new and improved servicing standards designed to correct some of the faulty servicing and foreclosure practices of the past, such as robo-signing and improper documentation.