Second Mortgages May Cost U.S. Banks $23B: Nomura

By James Sterngold - Oct 8, 2011 3:29 AM GMT+0700

Losses on home-equity and other second mortgages may cost the four biggest U.S. banks $22.6 billion more than budgeted, with Wells Fargo & Co. (WFC) most at risk, according to Glenn Schorr, an analyst with Nomura Holdings Inc.

The tally for Wells Fargo, the largest U.S. home lender, may reach $8.79 billion after accounting for taxes and existing provisions, followed by Bank of America Corp. (BAC) at $6.2 billion, JPMorgan Chase & Co. (JPM) at $5.51 billion and Citigroup Inc. (C) at $2.12 billion, Schorr told clients in a report today. Before taxes and reserves, losses could total $73 billion, he wrote.

While the losses may be large, “we don’t see this as a ticking time bomb” for banks because of reserves and the damage will be spread over a long period, Schorr wrote. “They will be given time to address any shortfalls.”

Regulators are examining whether banks accurately valued home-equity and other second-lien mortgages and if they’ve put enough aside to cover losses, seven people with knowledge of the matter have said. Investors are skeptical about the true worth of assets held by U.S. lenders, pushing the KBW Bank Index (BKX) down about 32 percent this year to 65 percent of stated book value for the 24 companies represented.

Measured by gross losses, the tally for Charlotte, North Carolina-based Bank of America could exceed $24 billion, while Wells Fargo, based in San Francisco, may lose as much as $20 billion, Schorr estimated. New York-based JPMorgan’s liability could be $19.5 billion, while New York-based Citigroup could see as much as $8.96 billion, he said.

Thomas Kelly, a spokesman for JPMorgan, Natalie Brown at Wells Fargo, Dan Frahm at Bank of America and Citigroup’s Shannon Bell declined to comment.

Underwater Loans

The loss estimates depend on how much equity is left in the house. For Citigroup, 44 percent of its second mortgages show the homeowner’s overall debt including first mortgages is greater than the price of the home, “which would suggest little to no recovery of value if a default occurs,” according to Nomura.

Debt exceeds the home’s value in 40 percent of Wells Fargo’s second mortgages, 36 percent at Bank of America and 27 percent for JPMorgan, Nomura said.

Holders of second liens can see their investment wiped out when a homeowner defaults because a lender with a primary mortgage gets first claim on the house in a foreclosure sale. If the value drops too far, nothing is left to pay the second lien.

Schorr said losses may not be as severe as they appear at first glance because some home-equity lines of credit are first mortgages. Bankers have said borrowers tend to keep making payments as long as they’re able, even if the home’s value is “underwater,” because they want to keep access to their line of credit.

To contact the reporter on this story: James Sterngold in New York at jsterngold2@bloomberg.net.

To contact the editor responsible for this story: Rick Green in New York at rgreen18@bloomberg.net