Opinion

Alison Frankel

What, us worry? Banks’ 3Q earnings downplay litigation exposure

By Alison Frankel
October 14, 2012

As I read the just-released third-quarter earnings statements of JPMorgan Chase and Wells Fargo, I felt as though I were living in a parallel universe to the banks. Looking for any mention of the New York attorney general’s encompassing $22 billion Martin Act suit against JPMorgan in the bank’s statement? You won’t find it. The only question on the AG’s case that JPMorgan CEO Jamie Dimon fielded in the Friday morning call with analysts was a softball asking whether, as a policy matter, it’s fair to hold the bank responsible for the alleged sins of Bear Stearns when the Fed pushed JPMorgan into the acquisition; Dimon, you will be shocked to hear, agreed that that’s not good policy. No one on the analyst call asked — and the bank didn’t say anything — about Libor liability or about the ongoing securities fraud class action stemming from JPMorgan’s nearly $6 billion chief investment office derivative hedge losses.

Wells Fargo made a fleeting reference in its call with analysts to a new suit by the Manhattan U.S. Attorney’s office, accusing the bank of defrauding the Federal Housing Administration about its mortgage underwriting practices, but didn’t happen to note that Bank of America settled a similar suit with Brooklyn federal prosecutors for $1 billion earlier this year. The U.S. Attorney’s suit was not mentioned in Wells Fargo’s earnings report. And neither Wells Fargo nor JPMorgan addressed the multibillion-dollar breach of contract (or put-back) claims they’ve received from a group of major institutional investors on allegedly deficient loans underlying mortgage-backed securities offerings. Wells Fargo has received formal notices of deficiency from noteholders with the requisite voting rights in trusts with a face value of $15 billion. JPMorgan is facing demands from noteholders in trusts with a face value of $95 billion.

But to hear the banks tell it, their litigation and put-back exposure is well under control. In Friday’s report, JPMorgan reported a $684 million expense for litigation reserves, which have historically included its reserves for put-back demands by private investors (as opposed to Fannie Mae and Freddie Mac). That seems to be up from the $323 million expense the bank reported in the second quarter, but it’s way down from $2.5 billion in the first quarter and $4.9 billion in 2011. (Those numbers come from a handy bank-by-bank report on litigation and put-back reserves that Natoma Partners put out last August.) On Friday, in response to a question about the litigation reserves, Dimon said they “would stay high for a while,” but also said that “on the private label stuff, we’re fairly well done.” Indeed, JPMorgan said that the additional $684 million in litigation reserves was “largely offset” by tax adjustments.

Litigation costs at JPMorgan are on a downward trend as well. A footnote in the earning statement says the bank had litigation expenses of $800 million in the last quarter, up from the previous quarter’s $300 million but way down from last year’s pace, when the bank shelled out $4.3 billion in litigation expenses in the first nine months.

But meanwhile, when you look at the bank’s reporting on outstanding repurchase demands by Fannie and Freddie, bond insurers and private investors, you’ll see that they continued to rise this quarter, all the way up to $4.1 billion from last quarter’s $3.5 billion, with $1.79 billion in claims coming just in the last three months. (That figure excludes put-back claims that are already being litigated.) JPMorgan is settling fewer put-back demands, though. Its realized losses were $268 million in the third quarter, up slightly from $259 last quarter but down from the three preceding reporting periods.

Bottom line: JPMorgan seems to be spending less, reserving less and settling less often on litigation and put-back claims, even though put-back demands are up and private and regulatory litigation against the bank has never been hotter.

Wells Fargo’s earnings report didn’t offer even as much detail on litigation as the scant information JPMorgan provided. The bank said its operating losses were down $232 million on “lower litigation accruals,” but it’s not clear to me what that means. The bank did not disclose its total litigation reserves in the earning statement, but said on the investor call Friday morning that those reserves include provisions for the U.S. Attorney’s new mortgage fraud suit.

Like JPMorgan, Wells Fargo is settling fewer put-back claims; as a result, it has more outstanding demands from Fannie and Freddie and private investors this quarter, with a total original loan balance of $2 billion, up from last quarter’s $1.67 billion. The bank added $462 million to its $2 billion put-back reserves, but that’s less than the $669 million it added last quarter.

We’ll know more when Wells Fargo files its 10-Q with the Securities and Exchange Commission, but the numbers in its earnings report don’t suggest that the bank is anticipating a big settlement with the institutional investor group that served the notice of deficiency on $15 billion in mortgage-backed securities. I reached out to the group’s lawyer, Kathy Patrick of Gibbs & Bruns, but didn’t hear back. I emailed Jen Zuccarelli at JPMorgan but did not immediately hear back. A Wells Fargo spokesman declined additional comment.

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