Who's Afraid of Foreclosure Crisis? Not Bank Investors

While the foreclosure mess is likely to play out for months and perhaps years to come, investors in banking stocks already appear to have braced themselves for the fallout and are ready to move on.


After having lagged the September-October rally that has sent the Standard & Poor's 500up more than 12 percent, banks are probably ready to rise, say analysts who have broken down the foreclosure scandal and what it will mean to the industry.

The stocks have underperformed—though still up about 7 percent—during the time period as investors pored through the crisis to see what impact it would have. Attorneys general in all 50 states have opened investigationsto see whether paperwork issues caused in part by so-called robo-signing of foreclosure documents needlessly caused some people to lose their homes.

While worst-case estimates have the losses totaling more than $100 billion, that's probably unlikely to cause major damage to bank stocks, which many analysts believe have already been priced in for the damage.

"The impact as can best be determined will be to delay but not prevent banks from achieving their normalized earnings power," Dick Bove, banking analyst at Rochdale Securities, wrote in a research note. "Book values are not expected to be lowered. The earnings disappointments inherent in this analysis may take 12 to 18 months to appear."

Most significantly, Bove wrote that the bank stocks are "meaningfully oversold."

The position is significant in that Bove is among the most downbeat of analysts when assessing the problem. On Friday, he wrote that banks could sustain hits of $82 billion collectively, more from lawsuits filed over the mortgage-backed securities used to package home loans than the amount they will spend on put-backs—the term given to banks being forced to buy back mortgage backed securities at par.

His peers have been working feverishly on similar analyses, and most have reached similar conclusions though on a smaller dollar scale.

They believe that while the problems will be significant, damage will be spread over years and investors already have been busy taking costs into account.

"We believe the potential costs will be spread out over a few years and represent an earnings drag but can be readily absorbed," analysts Christopher Mutascio and Brian J. Zabora, of Stifel Nicolaus in Baltimore, told clients. "Our estimates are materially lower than some of the more bearish views out there."

Stifel put the total loss figure at a more sanguine $47 billion, with $9.5 billion specifically to Bank of America. The bank is widely considered to have the greatest exposure to securitization issues, with $435 billion in private-label deals issued by BofA and Countrywide combined from 2005-08. BofA bought out Countrywide as the financial crisis raged in January 2008.

JPMorgan Securities, in analyzing the situation, said total exposure could go as high as $120 billionbut probably will be much less as most of the errors turned up likely are to be "process oriented" and fixable.

"In short, we believe that most of these issues are technicalities that will be overcome easily...or are nonissues," JPMorgan analysts said. "The putback risk from (government-sponsored enterprises such as Fannie Mae and Freddie Mac) and non-agency loans will represent a liability to the banking industry, but we estimate that to be in the range of $55 billion."

Investors seemed to be buying into the notion that the damage would be minimized for the banks.

The S&P 500 financial sector gained as much as 1.5 percent Mondayafter leading the market lower Friday. The group has been trading below its 200-day moving average and could be poised for a rebound after losing 2.5 percent in the prior week.

"What happened last week, if you look at in terms of the market cap that was lost vs. what the actual economic damage is going to be, the large banks present a significant opportunity," Josh Rosner, managing director at Graham Fisher, said in a CNBC interview.

There are areas of caution, however.

Credit Suisse warned that some regional banks, despite their limited exposure to the foreclosure mess, could get lumped in with their larger peers and take some hit to share price.

"[M]ost regional banks have little risk due to small MBS operations...however the market may group the banking industry together," analyst Craig Siegenthaler wrote. "We recommend investors who wish to avoid near-term pressure, to reallocate to the US Asset Manager Industry (which may be at the other end of the lawsuits)."

But Rochdale's Bove pointed out that losses overall likely will be offset by improvements in other parts of bank portfolios, particularly in writedowns they have been taking for poorly performing or nonperforming loans.

"If the loan loss provision declines, earnings will in fact advance. Book values will grow," he said. "The stocks are simply oversold."