Mortgage Settlements May Not Be Smooth Sailing for Banks

Litigation risk reserves are likely to increase, affecting bank earnings because of an expected $50 billion in legal settlements to come, The New York Times estimates.

In order to put the flood of government-related mortgage litigation behind them, banks will be forced to increase their litigation reserves, notes James Frischling, president of NewOak Capital in his blog.

Such measures will impact the earnings of all sizes of banks and are “likely to create headwinds in the financial sector, which returned 26% in 2013,” he says.

Like most analysts Frischling anticipates “a number of big banks” will report lower earnings and revenue due to losses from legal settlements and higher reserves needed to comply with these settlements and pending litigation. The recent $13 billion settlement between JPMorgan and the government is just one of the examples.

If until now banks have been able to manage earnings mainly by “taking cost-cutting measures,” returns to this strategy are diminishing.

In addition, the expected decline in mortgage refinancing as mortgage rates increase coupled with “the start of the government tapering,” he argues, will force banks to find new sources of earnings growth in 2014.

Despite the size of the expected settlements, however, he finds, “the numbers are manageable.”

Drivers include banks’ desire to put the fight with the government behind them, still-low interest rates and a pick-up in capital markets.