$17 billion. That's how much stock
market value
has been wiped out at
Bank of America (
BAC
)
in the latest foreclosure mess.
JP Morgan Chase (
JPM
)
has seen its value shrink by several billion dollars, while
Citigroup (
C
)
and
Wells Fargo (
WFC
)
have seen their stocks hold their own through this latest debacle.
Wall Street analysts think that the scandal is not likely to have a
big impact on these banks, and have started to suggest their shares
are compelling buys. And they're right. But you'd be foolish to
jump on just yet, with possibly daunting headlines looming in
coming weeks.
Lemon laws not in effect
As a quick recap, it has become increasingly apparent that these
banks botched the foreclosure process for many homeowners. To make
amends, they may need to re-work many loans, which would reduce the
value ofmortgage bonds by tens of billions of dollars. The major
institutions that bought those bonds, such as the Federal Reserve,
PIMCO and BlackRock Investments are crying foul, fearing that they
will have to shoulder many of the losses. So they want the big
banks, most notably Bank of America, to consider buying back
massive amounts of loans and absorb the big hit that may be coming.
In the past few days, those beleagueredbond investors appear to be
gaining the upper hand. To find out just what was in thosebond
portfolios (and ultimately prove that the banks were negligent in
handling mortgages), thebond investors need to come together to
represent at least 25% of the entire purchase of thosemortgage
bonds. A pair of law firms is leading the charge, and each looks
set to cross that threshold soon. When that happens, look for
lawsuits with 12 figure sums attached (that's $100 billion).
To be sure, banks won't be on the hook for all of the dud loans,
only those where negligence and a lack of
due diligence
was involved. All of the banks, including Bank of America, will
likely be able to pay out claims through
cash flow
rather than having to sell stock. Yet it will take an awfully long
time to sort out the mess, and who knows how theeconomy will fare
as the process drags on. If theeconomy slows from here while
lawsuits are being settled, banks may need to come up with large
sums of money right at a time when operating cash flow is
evaporating.
A wide range of numbers
How much money are we talking about? A group ofmortgage bond
investors led by PIMCO and BlackRock are asking Bank of America to
buy back $16.5 billion in dud loans. That's only part of the
estimated $47 billion in troubled loans that Bank of America may
ultimately be on the hook for. Throw inmortgage bonds from other
issuers, and the total industry exposure exceeds $100 billion. (The
Federal Reserve bought back more than $1 trillion in loans, and is
likely to seek some sort of massive payment -- known as
"put-backs.")
An over-reaction?
Wall Street firms that follow these banks think investors may be
over-estimating total industry exposure. They note that these
lawsuits have to prove that eachmortgage was dubiously processed,
and only those that have clear malfeasance will be subject to
put-backs. So analysts think exposure will be in the billions, not
tens of billions. They note that banks can easily overcome any
payouts that will be necessary, and as they look past this morass,
they see shares that are now undervalued in the context of eventual
"normalized"earnings .
That may well be true, and when the full impact of this debacle is
sorted out, and "headline risk" is no longer of concern, then
investors will likely hop back on to these stocks. But in the
near-term, shares could get hit again and again as lawsuits fly and
the Federal Reserve looks at what actions to take. Moreover,
estimates about total exposure are all over the place, and until
investors can truly peg the banking industry's exposure, few
investors will want to touch these stocks. For example, Credit
Suisse pegs potential industry exposure at $65 billion. If they're
right, shares of some stocks such as Bank of America and JP Morgan
Chase could fall well further.
Action to Take -->
There is one major bank that still holds appeal in this current
environment: Wells Fargo, which has relatively small exposure to
this crisis and may actually benefit from rivals' distress. [My
colleague Ryan Fuhrman recently called Wells "
The Best-Managed Bank in America
"] If the
mortgage
underwriting
business gets back on its feet in 2011 or 2012, Wells Fargo is much
more likely to have the wherewithal to write fresh loans, as it
won't be operating under a dark cloud. Shares, at a recent $26,
look to have +50% upside when theeconomy starts to improve.
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
More...
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.