Wells Fargo Mortgage Business Could Hit a Snag on Foreclosure Court Rulings

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Wells Fargo ( WFC ) is a diversified financial services company headquartered in San Francisco. It is the fourth largest bank in the US by assets and the second largest bank by market cap. It is also the second largest bank in deposits, home mortgage servicing, and debit cards in the US. Wells Fargo's significant exposure to the US housing market created a mess during the housing melt down in 2008-09, whereupon the bank accepted $25 billion from Troubled Asset Relief Program (TARP).

Most other Wall Street banks experienced similar turbulence during this period due to mortgage related exposure including competitors Goldman Sachs ( GS ), JP Morgan ( JPM ), Citigroup ( C ), UBS ( UBS ) and Bank of America (BAC).

The mortgage division is Wells Fargo's largest value driver constituting nearly 30% of the firm's value. However, a recent ruling by a Massachusetts court against Wells Fargo in a foreclosure case indicates a trend that could result in downside to our $37.92 Trefis price estimate for Wells Fargo's stock .

Wells Fargo's mortgage revenues nearly tripled in 2009 due to an improvement in the economic environment resulting in lower credit loses in addition to the acquisition of Wachovia Corporation. In 2009 Wells Fargo's fully repaid the U.S. Treasury's $25 billion Troubled Asset Relief Program (TARP) Capital Purchase Program (CPP) preferred stock investment, including related preferred dividends.

Court Ruling Against Wells Fargo in Foreclosure Case

The highest court in Massachusetts ruled that Wells Fargo & Co. and U.S. Bancorp could not foreclose on homes where loans were not repaid over the doubt that home loans were not properly handled when they were securitized. The court's decision to void the foreclosure sales of two homes in Springfield came as owners of the loans couldn't prove that the mortgages had been assigned to them. Both loans were packaged as mortgage-backed securities and sold to investors. The poor documentation of mortgage loans made it difficult to trace ownership and enforce legal issues.  (( Two Banks Lose in Foreclosure Cases , The Wall Street Journal))

The case has come as a potential blow to Wells Fargo and could set a precedent for other cases. This could have a large impact as we estimate mortgage backed securities (MBS) to be about $3 trillion (making up nearly 22% of the total mortgage debt outstanding in the US, down significantly from 53%, or $7.5 trillion, in 2009). ((Mortgage Debt Outstanding, Federal Reserve))

It might also lead to fresh claims from mortgage-bond investors who have earlier accused and even sued servicers for systematically poor loan documentation.

Potential Downside to Wells Fargo

While Wells Fargo claims that the ruling "does not prevent foreclosures on loans in securitizations," it could still have still have serious implication for Wells Fargo. The inability to foreclose on home loans (nearly 22% of all home loans) could result in higher credit losses on home mortgage loans  (represented by provisions as % of home mortgage loans) for Wells Fargo.

We estimate a 1% increase in provisions for credit losses as a % of home mortgage loans would result in 18% downside to our price estimate for Wells Fargo stock.

To see the impact of provisions as % of home mortgage loans, drag the trend lines in the modifiable charts above.

Our complete analysis of Wells Fargo's stock is here .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: C , GS , JPM , UBS , WFC

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