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Wells Fargo Settles Mortgage Repurchase Row With Freddie Mac For $869 Million

By: Trefis
Posted: 10/3/2013 1:19:00 PM
Referenced Stocks: BAC;C;WFC

Wells Fargo ( WFC ) has agreed to settle all repurchase claims related to the faulty mortgages it sold Freddie Mac before 2009 for $869 million. The settlement puts to rest a bulk of the legacy mortgage issues the banking giant took on with the acquisition of Wachovia in 2008 at the peak of the economic downturn. The country's largest mortgage originator finalized the deal late last week - just two days after Citigroup ( C ) announced that it had reached a similar agreement with Freddie Mac for $395 million (see Citigroup Settles All Mortgage-Related Grudges With Freddie Mac For $395 Million ).

Thanks to repurchase credits the bank has earned over the years with Freddie Mac, the final lump sum figure that Wells Fargo will have to shell out is roughly $780 million. The deal will have no negative impact on the bank's quarterly performance figure due for release next Friday, however, as it has already set aside more than enough cash to take care of the settlement amount.

While no doubt a bit of positive news for the bank's value, the settlement does not really warrant any change to our $46 price estimate for Wells Fargo's stock .

See our complete analysis of Wells Fargo here

In 2011, when mortgage insurers tightened their belts to cut losses by rejecting much more claims than they had in previous years, they created a ripple effect that hit the country's largest banks (see BofA Feels the Heat From Fannie Mae Repurchase Demands). This is because the rejected claims added to losses for the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac - who in turn jacked up their mortgage repurchase demands to pass on the losses to banks who originated the mortgages in the first place. Quite notably, a large chunk of these mortgages were originated during the housing boom between 2006 and 2008.

The banks have been caught up in a legal tussle with Fannie Mae and Freddie Mac since early 2012, with both sides haggling on how many of the failing mortgages each party is actually liable to repurchase. But with a number of lawsuits claiming misrepresentation of mortgage quality going against the banks, they were left with no choice but to set aside a considerable amount of cash to cover repurchase requests over subsequent quarters.

To put things in perspective, Wells Fargo had unresolved repurchase requests from the GSEs for 6,313 mortgages originated by it with a total value of $1.4 billion at the end of Q2 2013. And a whopping 89% of this repurchase requests were for loans over the 2006-2008 period - working out to about $1.25 billion. Wells Fargo also has additional $258 million in mortgage repurchase claims from private parties and declares that another $127 million worth of loans could draw a repurchase request in the near future - adding up to a total liability of just under $1.8 billion.

But then, Wells Fargo also set aside $2.2 billion in reserves for repurchase demands by the end of Q2 2013 - which highlights the bank's belief that the actual liability was quite a bit more than those already claimed by various parties. The settlement with Freddie Mac hence makes a lot of sense, as it caps the liability from a major bulk of mortgages under fire - allowing Wells Fargo to move ahead of this nagging legacy issue.

Although this settlement will not have an impact on the bank's results, you can understand the downside risk that exists to Wells Fargo's share price from larger-than-expected litigation expenses by making changes to the chart below.

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