In what is the first among a series of anticipated settlements by JPMorgan Chase (NYSE:JPM) with the country’s financial regulators, the banking giant put to rest its legacy mortgage-related issues with the FHFA as well as government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac for a total cost of $5.1 billion. ((JPMorgan Chase Reaches Settlements with The Federal Housing Finance Agency, Freddie Mac and Fannie Mae, JPMorgan Press Releases, Oct 25 2013)) The deal, which was announced last Friday, will see JPMorgan pay the FHFA $4 billion as total settlement costs and shell out an additional $1.1 billion to repurchase some of the mortgages it sold the GSEs. The settlement resolves the largest mortgage-backed securities (MBS) litigation faced by JPMorgan – representing a majority of the overarching $13-billion-dollar deal the bank has been looking to finalize with the federal government for some time now.
With this, JPMorgan also became only the second banking group to resolve all outstanding issues with the FHFA, Fannie Mae and Freddie Mac after Citigroup (NYSE:C), which managed to do so last month (see Citigroup Settles All Mortgage-Related Grudges With Freddie Mac For $395 Million). While the terms of Citigroup’s settlement with the FHFA were not disclosed, the fact that the size of Citi’s MBS under litigation were about one-tenth that for JPMorgan ($3.5 billion vs. $34 billion) indicates that Citi would likely have paid less than half a billion dollars in penalties to the FHFA in addition to separate mortgage repurchase agreements costing almost $1.4 billion (see Citigroup Settles Mortgage-Related Lawsuit With FHFA).
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We maintain our $60 price estimate for JPMorgan’s shares, as the bank had already set aside more cash than needed to cover this settlement in the third quarter.
The country’s largest banks have been under a lot of pressure over the recent years from Fannie Mae and Freddie Mac to repurchase a large chunk of mortgages, most of which were originated during the housing boom between 2006 and 2008. The issue itself arose when mortgage insurers began tightening their purse strings in 2011 and started rejecting many more claims than they had in previous years – forcing Fannie Mae and Freddie Mac to take billions in charges for all the mortgages which went bad. To make things worse for the banks, the FHFA also stepped into the picture in 2011 and launched a legal battle against them in a bid to make them pay for the billions in losses they inflicted on the GSEs by downplaying the underlying risks involved in mortgage-backed securities they originated.
JPMorgan was under fire over mortgage-backed securities worth $33.8 billion which were purchased by the GSEs between 2000 and 2008. Quite notably, a large part of this figure is made up of mortgages originated by financial giants Bear Stearns and Washington Mutual, which were acquired by JPMorgan with federal assistance at the peak of the economic downturn. The bank is expected to finalize the larger agreement involving the Department of Justice and other federal agencies in the near future, with the total bill size estimated to be around $13 billion.
What remains to be seen is the terms under which the agreement is reached as they could in turn spur a string of additional lawsuits against the bank by institutional investors – heavily adding to its legal costs and shrinking its margins in the future.