Just when you think banks should run out of shoes to drop, they give you a reason to think they're centipedes.

The latest case of falling footwear involves a potential liability of $17 billion or more from civil lawsuits related to foreclosure methods such as robosigning. Some government officials are pushing for a settlement of more than $20 billion. On top of that, the Justice Department is asking for another $500 million to $1 billion in penalties. Justice and the Department of Housing and Urban Development could potentially file claims for billions more. Banks had hoped to settle for $5 billion, but federal and state officials have dismissed that proposal.  

But, hey, $20 billion or thereabouts must be pocket change to an industry that received hundreds of billions in TARP bailout funds, right? Not so fast. For the first quarter -- banks' most profitable since before the financial crisis—the industry earned $29 billion.

The usual suspects
The banks at risk of having to pay out billions to settle include the usual suspects: Bank of America (NYSE: BAC), JPMorgan Chase (NYSE: JPM), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC). That said, based on the value of residential mortgages as a percentage of total capital, some of these suspects could be more exposed than others:


Residential Mortgages
(in millions)

Total Capital
(in millions)

Residential Mortgages as % of Total Capital

Wells Fargo $326,384 $147,100 222%
Bank of America $274,536 $229,094 120%
Citigroup $151,469 $162,219 93%
JPMorgan Chase $134,284 $182,216 74%

Source: Capital IQ, a division of Standard & Poor's.

Foolish takeaway
The cost to settle charges surrounding improper foreclosure practices could be a huge negative surprise -- and earnings drag -- for banks and their investors.

How many more shoes will banks drop? Fee income is under pressure. Loan demand could remain weak for years. Real estate continues to struggle. Excluding "provisions" (one-time items and unsustainable loan losses), banks' profits are in trouble. The value of assets on their books is suspect. Now the robosigning scandal could lead to fines and penalties that add up to more than two-thirds of their first-quarter profits. With all these potential pitfalls ahead, investors should be wary of buying into bank stocks -- at least until that last loafer finally hits the floor.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.