Mortgage Mess Weighs On Banks



If you don’t believe the devil is in the details, ask a banker.

Others believe the issues bedeviling banks and bank stocks are about more than mere “details,” that banks’ problems stem not from typos but from negligence at both the front and back ends of the mortgage process.

The allegedly shoddy paperwork coming to light in the foreclosure process has strengthened the arguments that banks weren’t exactly dotting every “i” and crossing every “t” at the front end of the mortgage process, either.

Most banks that originated mortgages didn’t hold all of them, instead packaging the mortgages and selling them to investors in a process called “securitization.” The problem for banks is that many investors who bought these mortgage-backed securities — and who saw their investments implode during the financial crisis — claim banks misrepresented the characteristics of those bundled mortgages. Thus, these investors are demanding that the banks buy back the investments at full price.

How deep is this problem? One estimate pegs the repurchase exposure for the bank that has become the poster child of the “put-back” problem — Bank of America ($13; BAC) — at nearly $50 billion, equal to nearly 40% of its stock-market value. Others say that neither Bank of America nor any other bank will pay full price to repurchase what some argue is potentially $100 billion in dud mortgage securities, that the banks will settle with investors for a lot less.

Partly due to uncertainty surrounding the put-back issue, banking stocks had underperformed until Nov. 4, when the group rallied on news that the Federal Reserve may soon allow “healthy” institutions to raise their dividends.

Our sole recommendation in the banking group is J.P. Morgan Chase ($41; JPM), the most financially sound of the major banks. J.P. Morgan’s put-back problem seems fairly well contained. The company said it has received demands to buy back $2.92 billion of bonds this year, versus $3.04 billion for all of 2009.

J.P. Morgan has set aside reserves of $3 billion for put-backs and believes it is through the worst of the repurchase demands, because the majority of the loans involved would have already gone bad. J.P. Morgan, trading at less than 11 times expected 2010 earnings, is rated Buy and Long-Term Buy.

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