Wells Fargo (NYSE:WFC) filed its 10-Q report for the second quarter of the year with the SEC this Tuesday, and from the looks of it even the model mortgage bank still has quite a lot of liabilities attached to its mortgage portfolio – both contractual and legal. The bank which runs the country’s largest mortgage origination and servicing business claimed that it could incur “reasonably possible losses” of $2.6 billion over and above the $1.8 billion it has already set aside as reserves to service mortgage repurchase requests. 
The increased repurchase liability can largely be traced back to the rising repurchase demands from Fannie Mae (FNMA) and Freddie Mac (FDMC) over recent months. This does not bode well for the other big mortgage players – Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C) – who have larger outstanding repurchase requests from these government-sponsored enterprises.
We maintain a $38 price estimate for Wells Fargo’s stock, which is a little more than 10% above the shares current market price.
The big banks have been under a lot of pressure over recent quarters from Fannie Mae and Freddie Mac to repurchase a large chunk of mortgages they originated between 2006 and 2008. The issue itself arose when mortgage insurers tightened their purse-strings beginning last year and rejected substantially more claims in 2011 than they had in previous years (see BofA Feels the Heat From Fannie Mae Repurchase Demands). Consequently, Fannie Mae and Freddie Mac ended up footing the bill for all the mortgages which went bad – forcing them to issue repurchase requests to the banks.
Banks have set aside notably more cash to cover repurchase requests this quarter than they did for any quarter in at least a year. The only exception was JPMorgan, which actually reduced its provision amounts, claiming that they had already set aside more money for such contingencies than was needed. As expected, Bank of America set aside the most as provisions to address its troubled mortgage portfolio – a total of $15.9 billion compared to Wells Fargo’s $1.8 billion. 
As a part of their respective regulatory filings, Wells Fargo, Bank of America and Citigroup revealed that they could lose an additional $2.6 billion, $5 billion and $4 billion respectively over the amount they have set aside based on their “worst-case scenario” estimates. To understand the impact of such a cost on Wells Fargo’s estimated value, you can make changes to the chart above.
Looks like troubles related to their mortgage businesses will haunt the banks for quite some time to come.Notes: