By David S. Hilzenrath and Zachary A. Goldfarb
Saturday, October 16, 2010; A9
Bank stocks got hammered for a second straight day Friday amid concern that mortgage issuers could face a new wave of red ink related to shoddy lending and foreclosure practices.
The share price of Bank of America, the nation's largest bank, fell 9.1 percent over the past week to close at a low for the year, as analysts said it might have set aside too little money to meet coming costs.
Companies that issued and service mortgages face a triple threat.
First, their efforts to seize and liquidate real estate held by delinquent borrowers may be delayed as they review reports of forged signatures, missing paperwork and other problems plaguing the foreclosures they have initiated.
Second, they could get drawn into a costly legal morass over allegations that they did not properly transfer loan documents when they pooled mortgages into securities that were sold to investors around the world.
Third, they could be forced to buy back billions of dollars of improperly issued loans that were sold to investors, such as the government-backed Fannie Mae and Freddie Mac.
The third issue is far from new, but it became cause for more concern this week as recent disclosures about sloppy or fraudulent documentation in the foreclosure process prompted investors to reassess the potential stakes.
The loan-servicing companies also face a Monday deadline from Freddie Mac to report any problems in their foreclosure practices.
On Friday, Standard & Poor's Equity Research downgraded Bank of America stock from "strong buy" to "hold." The ratings firm said it had "a lower level of confidence" that the bank "has adequately prepared for, and reserved for, future mortgage repurchase demands . . . and for the potential administrative and legal costs of the foreclosure crisis."
In an interview, Standard & Poor's analyst Erik Oja said that the crisis "threatens to morph into something perhaps uncontrolled . . . something very difficult to quantify."
Bank of America is seen as especially vulnerable because it took over Countrywide, one of the firms most heavily criticized for its lending practices during the housing bubble. Bank of America's shares fell 4.9 percent Friday.
As of mid-year, the bank faced unresolved claims that it repurchase $11.1 billion of problem loans, according to its last quarterly report. The bank had put $3.9 billion in reserve to cover such costs.
Bank of America is scheduled to release its next quarterly report Tuesday. A bank spokesman declined to go beyond past disclosures.
Other major banks felt the sting of the foreclosure crisis Friday. Wells Fargo's stock fell 4.6 percent, JPMorgan Chase's fell 4.1 percent, and Citigroup's fell 2.7 percent. By contrast, the Standard & Poor's 500 index, a broad measure of the stock market, rose slightly.
The sharp price movements are partly a reflection of confusion and uncertainty about the scope of the problems and how they will play out. Against that backdrop, a bearish report written in August by a hedge fund called Branch Hill Capital gained widespread attention this week, contributing to the sell-off.
The Branch Hill report said Bank of America could face losses of $74 billion on loan repurchases. The hedge fund disclosed that it was betting that the bank's stock or bonds would decline, and by influencing investors' outlook the report might have helped that bet pay off.
In a rebuttal this week, Oppenheimer & Co. analyst Chris Kotowski said the report was "demonstrably exaggerated and sensational." Oppenheimer disclosed that it, too, might have a conflict because it does business with companies it analyzes.
Fannie and Freddie are threatening to penalize banks if they do not rapidly fix their foreclosure processes.
Delays in foreclosures could cause a profound cash-flow problem for Fannie and Freddie, said Karen Shaw Petrou of Federal Financial Analytics in a report.
The companies have told banks that they will have to pay for any costs the mortgage giants incur as a result of foreclosure delays and are trying to force the banks to buy back billions of dollars of mortgage investments. Goldman Sachs analysts said Friday that these expenses could total $44 billion for the banking industry.
Fannie and Freddie maintain that they were sold the disputed mortgages on deceptive grounds - and that the banks that sold them the loans should be held responsible for the resulting losses. But the industry has resisted efforts by Fannie and Freddie to obtain documents that would show whether the investments were aboveboard.
The Federal Housing Finance Agency, which oversees Fannie and Freddie, recently subpoenaed 64 firms for loan applications, property appraisals and other documents that would show whether Fannie and Freddie or the banks ought to be liable for losses on the mortgage securities.