Posted on 27 Mar 2013 by Neilson
Large global banks' legal tab is poised to soar beyond $100 billion as investors, insurers and municipalities pursue damages for actions tied to the mortgage meltdown, the financial crisis and the rate-rigging scandal.
This month, Citigroup Inc. agreed to pay $730 million to settle claims it misled investors in four dozen bond and preferred-stock offerings. Deutsche Bank AG cut its 2012 profit target by 60%, citing higher U.S. mortgage- litigation reserves. Government-controlled mortgage investor Freddie Mac sued more than a dozen big banks, claiming they colluded to manipulate the London interbank offered rate, or Libor.
Concerns over banks' exposure to costly legal action, and whether they have reserved enough to cover costs without reducing future profit, continue to weigh on lenders' shares. While earnings have been rising, capital cushions are thicker and the U.S. economy is expanding, many of the largest financial firms are trading below their book value, or net worth.
"There always seems to be another negative headline, and that has kept investors on the sidelines," said Jason Goldberg, an analyst with Barclays PLC.
The largest U.S. banks--Citigroup, J.P. Morgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. --together have paid $61.3 billion to settle credit-crisis and mortgage claims over the past three years, according to SNL Financial, in Charlottesville, Va. Research firm Compass Point Research & Trading LLC estimates U.S. banks will wind up owing a further $24.7 billion related to the repurchase of faulty mortgage loans.
And it isn't clear how large their obligations could be in a case that is only now taking shape: alleged Libor manipulation.
Libor threatens to trump the mortgage-related litigation because of the sheer scale of the alleged wrongdoing. The interest rate is linked to hundreds of trillions of dollars in loans and financial contracts and was called the "world's most important number" in 2009 by the British Bankers' Association, a phrase now cropping up in myriad lawsuits. The association is responsible for managing the rate-setting process.
The estimates for damages vary widely, ranging from the $7.8 billion that Morgan Stanley predicts banks will owe to the $176 billion estimated by Macquarie Research.
"Libor is the big unknown right now, because it's still playing out at the preliminary stages," said Micah Green, co- chairman of the financial-services practice at law firm Patton Boggs LLP in Washington.
Barclays, UBS AG and Royal Bank of Scotland Group PLC have agreed to Libor settlements with U.S. and U.K. regulators totaling about $2.5 billion. Investigations into other banks are continuing. Representatives of Barclays, UBS and RBS declined to comment.
Large investors that are weighing potential claims include the California Public Employees' Retirement System, BlackRock Inc., Vanguard Group Inc. and Federated Investors Inc. Plaintiffs in private lawsuits must prove not only that the banks manipulated the interest rate but that they also sustained damages as a result.
Analysts and investors disagree over whether banks are sufficiently reserved for future claims, and bank disclosures on the subject are skimpy. Any amount banks owe in excess of reserves could crimp profits down the road and restrict their ability to reward investors with dividends and share buybacks. Bank executives generally believe their shares are undervalued and regard dividends and buybacks as a tool in winning favor in the market.
Legal decisions could hold considerable sway in whether banks' reserves prove adequate. A September decision by the Second U.S. Circuit Court of Appeals in New York could increase the size of class-action suits by allowing the lead plaintiff to represent a class of securities beyond those the plaintiff invested in directly, some legal observers said.
"Existing classes will now cover larger and larger filings," said Isaac Gradman, a litigation attorney with Perry Johnson Anderson Miller & Moskowitz LLP in Santa Rosa, Calif. "Plaintiffs who didn't get their act together to sue can now opt into these larger class actions."
Likewise, U.S. District Judge Jed Rakoff in February potentially made it easier for plaintiffs to sue by removing a costly and time-consuming hurdle to discovery. In Assured Guaranty Municipal Corp. v. Flagstar Bank FSB, Judge Rakoff ruled that a statistical sampling of loan files was adequate to determine underwriting breaches as opposed to the more arduous process of examining files loan by loan that the banks had favored.
"While the ruling will likely be appealed, the reality is that it significantly heightens the risks" to large banks, wrote Josh Rosner, an analyst with Graham Fisher, in a note to clients.
Even investors who are bullish on bank stocks said they can't help worrying about the legal risks. "It doesn't help that the government keeps suing these banks," said Randy Warren, chief investment officer of Warren Financial Service in Exton, Pa., which has $80 million under management.