A number of U.S. banks reported lackluster results last week because of the costs of legal settlements and set-asides to cover future legal liabilities. The numbers were not surprising given the wave of legal and regulatory enforcement actions that have hit the big banks in 2013.
What settlements mean for investors
The questions for investors are if and when the housing market recovery will strengthen in 2014, and the extent to which future legal cases brought by the Feds or private civil class actions will pick the big banks deep pockets.
Moreover, JPMorgan Chase (NYSE:JPM) head honcho Jamie Dimon's statement intimates these cases may have underlying political motivations:
We continuously evaluate our legal reserves, but in this highly charged and unpredictable environment, with escalating demands and penalties from multiple government agencies, we thought it was prudent to significantly strengthen them.
The keywords there are "highly charged and unpredictable." This is something to be wary of since 2014 midterm elections are on the docket. Investors in the banking sector should consider the legal and regulatory risks in their financial analysis. That being said, investors with a long-term view should look beyond these legal woes.
JPMorgan posts red ink
JPMorgan Chase reported a rare loss for the three months ended September 30. The loss was mostly due to the billions the big bank set aside to cover future legal costs.
Jamie Dimon and company have been hit with a wave of federal lawsuits and regulatory enforcement actions related to the London Whale blunder and mortgage securities offerings tainted by bad mortgage paper.
The big bank reported a net loss of $0.4 billion for the third quarter of 2013, compared with net income of $5.7 billion in the third quarter of 2012. Earnings per share were minus $0.17 compared with $1.40 in the third quarter of 2012. The bank also recorded a $9.2 billion expense in order to build its litigation reserves.
That's a big war chest, so investors should take note because the bank will be in the legal trenches for the next several quarters. While more legal settlements may be an impediment to earnings in the short term, these cases are more of a black eye than a threat to JPMorgan's fundamental strength.
SunTrust settlements trim profits by $179 million
SunTrust (NYSE:STI), the Georgia domiciled lender said third-quarter earnings will be cut by $179 million -- $0.33 a share -- after settlements with the Fed over claims tied to faulty mortgages.
SunTrust will cough up $500 million in borrower assistance and a cash payment of $468 million to the U.S. Justice Department and the Department of Housing and Urban Development (HUD). The agreement covers mortgage loans originated from Jan. 1, 2006, to March 31, 2012, resulting in a $323 million charge in the third quarter.
Further, the Federal Reserve also handed down a $160 million sanction against SunTrust related to shoddy residential mortgage loan servicing and foreclosure processing. The lender said it will pay this penalty as part of the above-mentioned $500 million in consumer relief.
Meanwhile, SunTrust also ponied up $373 million to Fannie Mae and $65 million to Freddie Mac to settle claims to cover refunds for bad mortgage paper sold to the housing giants from 2000 to 2012.
Going forward, a bigger challenge than these legal costs is the shape of the U.S. Housing market, which has cooled off in the second half of 2013. However, with these legal troubles behind them, SunTrust will see gains if and when the next phase of the housing recovery kicks in.
Holding steady despite legal headwinds
Well Fargo (NYSE:WFC) also acknowledged that legal costs were a fly in the ointment. The most revealing bit of news was buried in the forward-looking statements, including so-called "negative effects" relating to the lenders mortgage servicing and foreclosure practices.
Well Fargo said its obligations stemming from the recent settlement with the Department of Justice and other federal and state authorities could result in "regulatory or judicial requirements, penalties or fines, increased servicing and other costs."
But the bank held steady and performed well in the third quarter. Wells Fargo recorded net income of $5.6 billion and diluted earnings per share of $0.99, up 13% from the third quarter 2012. The nation's largest lender was buoyed by improved credit quality even though mortgage originations volume dipped.
The bottom line
Investors shouldn't panic over these legal foibles. The broader banking sector has recovered from the financial crisis of 2008, and a period of legal actions and enhanced regulatory scrutiny was inevitable. But the banks have weathered the storm and remain fundamentally strong.
Kyle Colona has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of JPMorgan Chase and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.