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Foreclosure Mess: The End?

Zacks Equity Research

After months of waiting, homeowners have something to cheer about. The five large U.S. banks – JPMorgan Chase & Co. (NYSE:JPM - News), Bank of America Corporation (NYSE:BAC - News), Citigroup Inc. (NYSE:C - News), Ally Financial Inc. and Wells Fargo & Company (NYSE:WFC - News) – accused of faulty foreclosure practices, have finally agreed to the $25 billion settlement deal.

Touted as the largest joint federal-state settlement ever, the foreclosure mess settlement deal includes 49 states’ attorneys general and federal agencies – the Department of Justice (DoJ) and the Department of Housing and Urban Development (:HUD). Only Oklahoma did not join the deal. The state separately entered into an $18.6 million deal with these five banks to receive its portion of funds from the settlement that will go directly to all the states.

Under the agreement, these banks are required to lower the loan amounts for about 1 million homeowners that are at a risk of foreclosure. Further, approximately 750,000 borrowers who lost their homes due to foreclosure, over the last four years, will get nearly $2,000 in cash. The banks have time till 2014 to fulfill the terms.

Allocation of Settlement Amount

Out of the $25 billion settlement money, nearly $17 billion will be utilized to help troubled homeowners through principal reductions and loan modifications. Moreover, another $5 billion will be given to the state and federal governments as a fund to provide compensation to homeowners who have lost their home as a result of misleading by some mortgage servicers. The remaining $3 billion will assist underwater borrowers – those homeowners, who at present are able to make mortgage payments, but owe more than the value of their property.

According to HUD, the settlement money received from the five accused banks will be divided between the regulatory authorities and distresses borrowers. Bank of America will be paying the largest share of settlement amount, which is nearly $11.8 billion. Out of this amount, $3.24 billion will be paid to states and the remaining to the distressed borrowers.

Similarly, JPMorgan will pay $1.08 billion to the states and $4.21 billion in relief, Wells Fargo will pay $1.01 billion and $4.34 billion in relief, Citigroup will pay $415 million and provide $1.79 billion in relief, and Ally Financial will pay $110 million and $200 million as a relief.

Other Terms & Conditions

Under the terms of the deal, the abovementioned five banks will be absolved from civil government charges over flawed foreclosure practices and the mishandling of loan modifications requests. The banks will be needed to fulfill new foreclosure servicing standards, including stricter oversight of foreclosure processing, no foreclosure before loan modification being considered and a single-point-of-contact for borrowers, among others.

However, the deal does not prevent the states and federal agencies from filing criminal actions over foreclosure activities against these banks. Additionally, homeowners can also sue these banks individually.

Other Settlements

Apart from the $25 billion settlement deal, there were three other agreements related to foreclosures, which are worth mentioning. The first one among these involves Bank of America, who will be paying nearly $1.36 billion to settle mortgage origination claim and certain settlement violation charges.

Another one is the deal between the aforesaid five banks and the Federal Reserve Board under which, these five banks will be paying nearly $767 million over foreclosure processing practices. Under the third one, the Office of the Comptroller of the Currency (:OCC) entered into a settlement with the five charged banks worth $394 million over mortgage and servicing practices.

Behind the Mess

At the time of foreclosing homes, many lenders use ‘robo-signers’ − employees who sign hundreds of documents a day without verifying decisive information like the previously outstanding amounts of borrowers. This is the primary reason behind this huge mess.

The problem intensified because of the negligence of homeowners and lawyers despite their awareness about the foreclosure rules.  Flawed paperwork also raised questions about the validity of the ownership documents. Hence, in October 2010, JPMorgan, Bank of America and Ally Financial temporarily suspended foreclosures across the country. Thereafter, a probe was launched by U.S. bank regulators and a task force of attorneys general of all 50 states.

Still a Long Way to Go

The deal is a big relief for the banks. If each state would have sued them individually and won, the total settlements could have run into hundreds of billions. This could have led the banks in to a serious financial crisis, even bankruptcy and could have taken the U.S. economy to the double-dip recession.

However, the settlement is only application to privately held mortgages and not to those owned by Fannie Mae and Freddie Mac that own nearly 50% of the total loans. Hence, all the borrowers will not get benefited from the deal.

Moreover, the settlement will enable the revival of the housing market, which is reeling under the effects of foreclosure mess and reduction in home prices. All these have made the country’s economic growth slow, which is further compounded by higher unemployment rates.

Still, we are hopeful that the deal would, to an extent, provide relief to the distressed homeowners and act as a blueprint for future settlements. It will also be a decisive step in restoring confidence in businesses and rejuvenating the sagging housing market.

Also, the banks who had been slow in foreclosing the properties will step up their actions, leading to an increase in foreclosure activity. Hence, we should now prepare ourselves for an exceptional rise in foreclosure activities over the next few quarters.

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