Fitch: Cost of Settling Looks More Expensive After UBS


After Switzerlands largest bank UBS reached an $885 million agreement with the government-sponsored enterprises last month to settle claims that it improperly sold them mortgage-backed securities during the housing bubble, Fitch Ratings thinks more banks will choose to fight any charges made against them in court rather than pay excessive costs like this.

Two years ago, FHFA filed 18 lawsuits alleging that banks misrepresented the quality of private-label mortgage securities sold to Fannie Mae and Freddie Mac before the financial crisis.

So far, only UBS, Citigroup and GE Capital have settled their lawsuits with the GSE conservator. However, the three settlements represent only 5% of the $200 billion in alleged losses with much of the bulk of exposure still outstanding.

The UBS case was resolved over $4.5 billion in residential mortgage-backed securities that the financial institution sponsored and $1.8 billion in original face value of third-party RMBS. The $885 million lump sum payment made by UBS represents approximately 14% of the $6.3 billion PLS original face value.

Although this settlement does not create a formal precedent, Fitch expressed that its high costs relative to the outstanding portfolio amount might lead to different provisions at other banks.

It is challenging to estimate the potential exposure for individual banks given the unique circumstance of each institution, Fitch said. Some of the banks have been involved in other settlements with the GSEs, which may impact their negotiations on the outcome of this litigation. This is likely to be a drawn-out process, similar to other PLS litigation, which will perpetuate uncertainty of ultimate losses.

The top three banks (Bank of America, JPMorgan Chase, and RBS), Fitch said, account for approximately 60% of the total losses outstanding, in which B of A makes up about half of this total.

Fitch stated outstanding balances are now down to a total of nearly $63 billion. About two-thirds of this amount come from the top three banks, while four banksFirst Horizon, Societe Generale, Nomura and Barclayshave outstanding balances below $1 billion.

According to Fitch, the quality and performance of the underlying PLS is likely to play an important role in the each banks ultimate exposure. The weighted average ratings of the current outstanding securities vary between banks, but all ratings are low, ranging from D to CCC for banks that have not settled yet.

Additionally, Intex, which tracks publicly available performance data of PLS, revealed that the aggregate loss rates for the underlying securities cited in each of the FHFA complaints fluctuate between 0.0% and 6.5%, while the current balances vary between 8.6% and 41.0% of the original balance.

Lastly, the New York-based ratings agency expects litigation and regulatory costs for the banking sector to remain high but manageable. Fitch added that statutes of limitation should result in a decrease in the number of new court filings during 2014, but current litigation matters are likely to drag on for a considerable amount of time.

Estimating potential litigation exposure is by its nature difficult if not impossible. However, Fitch believes that improved and more consistent disclosure could help investors size the potential maximum exposure that banks face, the agency said.

Additional information could include the performance of the underlying securities and maximum exposure estimates, which have been disclosed by HSBC, Fitch continued. It would also be helpful to know the size of the Citi and GE settlements, which have not been disclosed by FHFA.

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