The latest deal inked between a banking giant and one of the government-sponsored enterprises (GSEs) over faulty mortgage-backed securities issued before the economic downturn of 2008 involves Wells Fargo and Fannie Mae, with the country’s largest bank in terms of market capitalization agreeing to shell out $591 million to put this legacy mortgage issue behind.  The deal comes three months after the bank settled similar differences with Freddie Mac for $869 million (see Wells Fargo Settles Mortgage Repurchase Row With Freddie Mac For $869 Million), and resolves one more of the long list of pending lawsuits between banks and GSEs. As in the case of the previous settlement with Freddie Mac, a bulk of the securities under question were originated by Wachovia before it was acquired by Wells Fargo at the peak of the recession. The bank is fully reserved for the payout.
Global banking giants worked hard in the latter half of 2013 to get the mortgage-related issues off their back, and to start 2014 with a clean slate. The three largest U.S. banking groups JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC) and Citigroup (NYSE:C) finalized their own deals with Fannie Mae and Freddie Mac over this period. Deutsche Bank (NYSE:DB), the largest German bank, also announced a €1.4 billion ($1.9 billion) deal with the GSEs recently. ((Deutsche Bank resolves its single largest mortgage-related litigation case, Deutsche Bank Press Releases, Dec 20 2013))
While no doubt a piece of good news for the bank’s value, the settlement does not warrant any change to our $45 price estimate for Wells Fargo’s stock - which is around the current market price.
In 2011, when mortgage insurers began rejecting more claims from the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac than they had in previous years to cut down on losses, the GSEs promptly starting pushing the losses towards the country’s largest banks by hiking their mortgage repurchase demands (see BofA Feels the Heat From Fannie Mae Repurchase Demands). Needless to say, a large chunk of the mortgages securities making heavy losses were originated during the housing boom between 2006 and 2008.
The banks have been caught up in a legal tussle with Fannie Mae and Freddie Mac since early 2012, with both sides haggling on how many of the failing mortgages each party is actually liable to repurchase. But with a number of lawsuits claiming misrepresentation of mortgage quality going against the banks, they were left with no choice but to set aside a considerable amount of cash to cover repurchase requests over subsequent quarters.
Data provided by Wells Fargo as a part of its third quarter earnings release show that the bank had unresolved repurchase requests from the GSEs for 4,412 mortgages originated by it, with a total value of $958 million at the end of Q3 2013 – a marked decline from the repurchase requests for 6,313 mortgages worth $1.42 billion at the end of Q2 2013, thanks to the settlement with Freddie Mac.  Almost 80% of these repurchase requests were for loans over the 2006-2008 period – working out to just over $750 million. Wells Fargo also has additional $264 million in mortgage repurchase claims from private parties and another $87 million worth of loans could draw a repurchase request in the near future – adding up to a total liability of $1.3 billion.
This is roughly in line with the $1.4 billion in repurchase reserves Wells Fargo had at the end of Q3 2013 – a figure that will decline by roughly $541 million, thanks to the settlement with Fannie Mae (including previous credits). While this settlement will not have an impact on the bank’s results, you can understand the downside risk that exists to Wells Fargo’s share price from larger-than-expected litigation expenses by making changes to the chart below, which captures the bank’s non-interest expenses as a percentage of its revenues.
- Wells Fargo Reaches Agreement Resolving Fannie Mae Repurchase Demands on Loans Originated Prior to 2009, Wells Fargo Press Releases, Dec 30 2013 [↩]
- Wells Fargo Reports Record Quarterly Net Income, Wells Fargo Press Releases, Jul 12 2013 [↩]