Banking Law

According to The Financial Times, Wall Street analysts are warning investors to start paying attention to a risk that we started yakking about five years ago: mortgage loan repurchase risk. FT journalist Tracy Alloway quotes Barclays Capital US analyst Jason M. Goldberg:

While most banks have guided to overall consumer losses peaking near term, we expect losses related to mortgage repurchases and indemnifications to continue increasing at least through the remainder of 2010. In fact, we believe this is an area that warrants close investor attention during the next several quarters, at least until we have moved through the remaining problematic 2007 vintages and into the 2008 and more recent vintages, as underwriting standards were strengthened in the middle to late part of 2008. Note in their recent 10-K filings, BAC said repurchase demands could ?significantly? increase its losses, while JPM commented the cost repurchasing mortgages sold to GSEs increased substantially, and could continue to increase ?substantially? further. Still, we view mortgage repurchases as more of an earnings issue than a capital concern, since while these expenses are large enough to depress earnings in any particular quarter, they are not big enough to materially impact banks? overall capital levels. This is an area we plan on paying particular attention to during the upcoming 1Q10 earnings season.

While Alloway notes that lenders like JP Morgan Chase are pushing back against repurchase demands by Fannie Mae and Freddie Mac (something we also discussed in an earlier post), and that JP Morgan Chase asserts that 50% of the buyback requests go unfulfilled, she also points out that Chase's last 10Q filing stated that "[i]t anticipates that its 2010 revenue could be negatively affected by elevated levels of repurchases of mortgages previously sold to GSEs." Thus, Goldberg's cautionary language about hits to earnings appears to be justified.

Fellow blogger Francine McKenna has previously discussed the issue of repurchase risk in the context of the failure of subprime mortgage lenders to adequately disclose this risk and of outside auditors to discover and require the lenders to disclose it. As Francine observed, these failures give ammunition to disgruntled investors and bankruptcy trustees, aided at all times by trial lawyers, to squeeze the last ounce of blood from the Big Accounting turnips who audited the failed lenders (or lenders who survive but whose earnings are hit by repurchases). Warnings by analysts like Goldberg about the impact on earnings of repurchases give the hunters of deep pockets additional ammunition to successfully assert that this is a risk that should have always been foremost in the minds of those with the duty to publicly disclose it.