The Risks of the Mortgage Mess: The Banks' View
I waded through the recently filed annual reports from Bank of America (BAC), JPMorgan Chase (JPM), Citigroup (C), Wells Fargo (WFC) and HSBC to see how each institution framed the threat that the mortgage mess and the foreclosure crisis pose to their businesses.
You'd expect to see plenty of similarities. After all, in general, the risks are well-known and common to all of those banks. For example, investors could force the banks to buy back securities; law-enforcement investigations could be costly; foreclosure problems could increase costs and losses; and lawsuits of every type could crop up.
Nonetheless, the differences in substance and style were striking, speaking volumes about the banks' attitudes toward the risks. Bank of America gives comprehensive, detailed disclosures. HSBC and Wells Fargo are also reasonably detailed. Chase is more succinct and vague, but doesn't downplay the risks. Citi is as brief as Chase, but uses a more aggressive, self-assured style that comes across as almost dismissive of the risks.
The banks' responses to requests for comment were likewise varied: HSBC and Bank of America provided comment, as discussed below. JPMorgan Chase's spokesman simply said "the disclosure lays out the facts for investors" and that additional detail was available from its recent "investor day." Wells Fargo spokeswoman Mary Eschet said the "disclosure speaks for itself." And Citi spokesman Jon Diat declined to comment.
Here's a discussion of each bank's disclosures and what it reveals:
HSBC: Document 'Deficiencies'
In its annual report, HSBC casually mentions the previously unannounced foreclose moratorium as part of a discussion of its growing foreclosure inventory: "Despite our cessation in processing foreclosures in December, our inventory of foreclosed properties continued to increase."
The foreclosure freeze may not be the only sotto voce announcement HSBC made in its annual report. In its risk disclosures, HSBC says two different regulators sent it letters "noting certain deficiencies in the processing, preparation and signing of affidavits and other documents supporting foreclosures. . .including the evaluation and monitoring of third-party law firms retained to effect our foreclosures."
That sounds suspiciously like robo-signing, or automatically signing documents without verifying their accuracy. But consistent with past HSBC statements, bank spokesman Neil Brazil insisted in an interview that HSBC didn't use robo-signers.
If that sentence wasn't about robo-signing, I asked, what "deficiencies" in the preparing and signing the affidavits does it refer to? Brazil stuck with the "we-don't-robo-sign" line, but didn't have an answer to the question.
Frankly, any answer that's not an admission of robo-signing would be worse. Does the sentence mean the documents were properly verified and signed, but HSBC's databases are so bad that the documents were wrong nonetheless? I mean, if that risk-factor language isn't an admission of robo-signing, what is it?
Also in its risk disclosures, HSBC says it's in discussions with regulators that would fix its foreclosure processes going forward. It faces the risk of costs associated with its foreclosure problems, as well as related litigation, general economic risk and risks related to mortgage securitization. It also notes that the foreclosure delays could hurt the housing market -- vacant properties can push down property values -- and thus HSBC.
Bank of America: Serious Details on Putbacks and Liability
Bank of America's annual report, filed on Feb. 25, devotes an entire section devoted to "Mortgage and Housing Related Market Risk." And topping that section's list is the risk that investors could force the bank to buy back mortgage-backed securities.
Fannie Mae, as well as private investors, have been trying to force banks to take back their junk mortgages. "The resolution of these claims could have a material adverse effect on our cash flows, financial condition and results of operations," Bank of America notes. A massive amount of money must be at stake for the gargantuan bank to consider those claims a material risk.
Further housing-market declines, including lower home prices, could hurt its mortgage business and -- perhaps more important -- worsen the risk of litigation over the mortgage and securities buybacks, potentially having "a significant adverse effect on our financial condition and results of operations," Bank of America says.
The bank is similarly straightforward in acknowledging many other risks, including its potential liability related to mortgage servicing and the possible damage to its reputation resulting from its foreclosure and mortgage-modification practices.
But the scariest risk in the report wasn't directly related to mortgages or foreclosures. Its very first risk, printed in the biggest font, is "Liquidity Risk," which translates into something like 'the risk that we'll need another bailout."
The detailed disclosures are typical of the company, according to Bank of America spokesman Jerry Dubrowski. "Over the last year, we've tried to be responsive to investors and their requests for information about our mortgage business, primarily," he says.
"I think if you listen to or look at the investor presentations or all of our SEC filings [and] our conference calls, we have spent a lot of time talking about our mortgage business, about repurchase claims, about foreclosures and modifications. And hopefully that information allows investors to better understand our business and the challenges we face."
Wells Fargo: Comprehensive, but Hard to Find
Wells Fargo's discussion of the risks posed by the mortgage mess also is fairly comprehensive. Like Bank of America, Wells admits buyback risks, as well as risks stemming from its mortgage-servicing practices and foreclosure practices.
One risk in particular is sure to warm the hearts of distressed homeowners. Wells warns that bankruptcy law might be changed to let a judge reduce the principal balance on an underwater mortgage, or one in which the buyer owes more than the property is worth, to the home's actual value. (That type of reduction -- called a cram down -- is currently allowed for limos, yachts and vacation homes, but not for primary residences.)
In case you're hoping to examine the risk disclosures yourself, you should note that Wells Fargo's disclosures are hard to find. The document labeled as the annual report on the Securities and Exchange Commission website is only 32 pages long, but the rest of the report -- and the part containing these mortgage risks -- is attached as Exhibit 13.
Chase: Robo-Signers Were Chase Employees
Like Bank of America and Chase, JPMorgan Chase discussed the risk of mortgage repurchases in its annual report. While Chase is sanguine that its reserves are appropriate, it includes a stark warning that it could be wrong.
In 2010, the cost of repurchasing mortgage loans from Fannie Mae and Freddie Mac "increased substantially" and could "continue to increase substantially," it says, adding that buybacks "could materially and adversely affect the Firm." It also notes that it faces substantial litigation related to its mortgage-backed securities.
More unique is Chase's disclosure about its foreclosure moratorium, which is has -- for the most part -- lifted. While it gives no details about which foreclosures are still suspended or how much of its foreclosure review has been completed, Chase says the moratorium was triggered by "questions about affidavits of indebtedness prepared by local foreclosure counsel, signed by Firm employees." Firm employees? Really?
It's a daring assertion. One of the hallmarks of the robo-signing scandal has been so-called bank "vice presidents" who have never received a paycheck from the bank, set foot in the bank's offices or reported to anyone at the bank. Instead, they really work for Lender Processing Services or its kin, signing documents according to corporate resolutions.
It's possible that Chase never outsourced its robo-signing. Certainly some robo-signers have been bank employees, such as Wells Fargo's John Kennerty. But I'd be surprised if all of Chase's robo-signing took place in-house.
Finally, Chase leaves investors with a warning about the various foreclosure-related investigations it faces: "The Firm is cooperating with these investigations, [which] could result in material fines, penalties. . .default servicing or other process changes. . . . or other enforcement actions, as well as significant legal costs. . . . The Firm cannot predict the ultimate outcome of these matters or the impact that they could have on the Firm's financial results."
Citigroup: Blaming the Whistleblowers
Citigroup's annual report, filed on Feb. 25, yields one long risk factor discussing both the mortgage buybacks and foreclosures. The bank says it has nearly $1 billion in reserve to buy back Fannie Mae and Freddie Mac mortgage-backed securities, and it thinks the liability for "private-label" securities is smaller. But it warns that the risk could grow as more lawsuits are filed.
Its language about other risks differs from that of the other banks, however. For example, it says the robo-signing scandal, questions about the securitization process, and all the law enforcement and regulatory attention that's ensued "has resulted in, and may continue to result in, the diversion of management's attention and increased expense, and could result in fines, penalties. . .principal reduction programs, and significant legal, negative reputational and other costs."
Diversion of management's attention? If management had been on the ball to begin with, these risks would never have been created. The most galling facet of the mortgage mess has been how avoidable it's been. I mean, who decides to employ robo-signers? Management. Who decides to use foreclosure mills and not supervise them? Management. Who decides to buy and securitize fraudulent mortgages? Management.
What exactly is this regulatory scrutiny diverting management's attention from? Figuring out the next way to maximize short-term gain (i.e. management compensation) at the expense of sound long-term business practices? Get real.
On the foreclosure front, Citi seems even less concerned, beginning with a claim that its "current foreclosure process is sound." Note the word "current." Citi does acknowledges that further "deficiencies" could "materialize," and that the whole industry could be hit with damaging regulatory or judicial actions. The primary threat that Citi sees is an increase in its foreclosure backlog, which would increase costs and reduce revenues.
Finally, in a risk factor unrelated to the mortgage mess, Citi warns that of another potential management diversion: whistleblowers. It says the Financial Reform Act's whistleblower provisions "provide substantial financial incentives for persons to report alleged violations of law," and adds that these provisions "could increase the number of claims that Citigroup will have to investigate or against which Citigroup will have to defend itself, and may otherwise further increase Citigroup's legal liabilities."
Citi is the only bank that mentioned this risk. Apparently, none of the other banks were worried enough about whistleblowers to include it. Although I'm not sure Citi is all that worried. The language reads more like a company annoyed with government meddling in its business.