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S&P: Repurchase obligations could weigh on banks' earnings

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Repurchase obligations could prove both contentious and costly to banks' earnings, with an estimated price tag of $43 billion total, according to a report published Thursday by Standard & Poor's Ratings Services. The report, "Mortgage Troubles Continue To Weigh On U.S. Banks," looks at how potential repurchase obligations, or putbacks, from breaches of representations and warranties that banks make as part of the mortgage underwriting process could affect the housing and financial markets. Already, the issue is slowing the housing recovery, the report suggests. Another S&P study said it could end up costing the six big U.S. banks that the agency rates about $43 billion from 2009 until 2012. S&P said it wanted to evaluate whether the growing repurchase requests could have an effect on banks’ earnings, weakening them going forward. "We believe that the banks have already accounted for about $12.4 billion of the potential $43 billion in losses on their income statements, which leaves about $31 billion of possible losses for the six banks in our study," said Standard & Poor's credit analyst Vandana Sharma. Bank of America (BAC) and JPMorgan Chase (JPM) account for most of this projected exposure, followed by Wells Fargo (WFC), Citigroup (C), U.S. Bancorp (USB), and PNC Financial Services Group (PNC). “In all cases, we believe that the representations and warranties matter is an earnings issue and is not likely to affect our view of the banks' capital adequacy,” S&P said. The potential earnings drag, estimated earnings reductions associated with Dodd-Frank and expected declining net interest income will likely hamper the financial recovery of banks next year despite declining credit costs, the ratings agency said. S&P said some of the representation and warranty breaches could include faulty foreclosure documentation related to the robo-signing scandal, but in general it sees the issue as separate. Banks in recent weeks have re-filed paperwork that was deemed faulty, but it may not be sufficient to resolve the issues, S&P said. “We view foreclosure delays as distinct and separate from repurchase requests arising from purported breaches of representations and warranties. "We do not believe that this issue … has come to a resolution. We expect that this will result in a slowing of foreclosure actions that may increase the severity of losses when the homes finally sell. At this time, we assume that the banks indeed have the right to foreclose based on a borrower's delinquency status. If it turns out that the bank did not have the title to a home for which the mortgage was securitized, the bank will likely have to buy that loan back from the securitization.” But S&P said they see that as a remote possibility. Still, the report said, “We remain concerned about the potential for growing litigation risk, where investors sue the banks, potentially resulting in more losses for the banks. As an example, although not necessarily related to this issue, JPMorgan built a legal reserve of $1.3 billion during the third quarter.” Write to Kerry Curry.

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