Yesterday, United States Attorney for the Southern District of New York filed a civil mortgage fraud lawsuit against Wells Fargo & Company (NYSE:WFC) seeking treble damages and civil penalties relating to WFC’s role in the FHA’s Direct Endorsement Lender Program. The lawsuit identifies approximately $190 million in insurance claims paid by the FHA on 6,320 defaulted mortgages that it alleges WFC failed to properly review and report to the FHA.

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But how big of a deal is this really? 

KBW thinks that a settlement is likely.

Morgan Stanley (NYSE:MS) has an interesting analysis on the impact to EPS.  They  believe the indemnification/penalty will be manageable and look for a settlement of ~$600mn (7c a share, 2% of 2013 EPS).

How do they figure?

They note Bank of America Corp (NYSE:BAC) paid ~$1bn as part of the State AG settlement to settle a similar claim primarily related to CFC loans originated prior to April 2009. They estimate this $1bn amounts to 0.75% of CFC’s FHA loan originations from 2001-2009.

Base case:

They apply this 0.75% to WFC FHA loans originated from 2001-05 (this case focuses on “reckless” loans made between May ’01 and Oct ’05). This gets them to $589mn (7c a share, 2.0% of 2013 EPS).

Bull case

120% of $190mn in FHA claims that Wells Fargo & Company (NYSE:WFC) allegedly knew were deficient but failed to report. This amounts to $228mn (3c a share or 0.8% of 2013 EPS).

Bear case

They apply the 0.75% to all WFC FHA loans from 2001-2009 (not just until 2005). This gets them to $1.8bn (22c a share, 6.1% of 2013 EPS).
It is likely the company has already reserved for part of the claim (WFC disclosed the investigation in last quarter’s 10Q). We look for further details at WFC’s 3Q12 earnings call on Friday Oct 12.

Further Details of the lawsuit

The US Attorney for the Southern District of New York and the HUD filed a civil fraud lawsuit against WFC, alleging that the bank 1)
originated FHA insured loans without meeting HUD’s underwriting requirements; and 2) failed to self-report deficient loans to the FHA, ignoring findings from its own quality control department. The complaint seeks treble damages and civil penalties for $190mn in FHA claims paid on ~6k improperly certified loans that Wells Fargo & Company (NYSE:WFC) reviewed but failed to self-report and “millions more” for loans it failed to review.

Wells Fargo & Company (NYSE:WFC) subsequently issued a statement saying its FHA delinquency rates were half the industry average, and that the bank would defend itself against this action.

Disclosure: the Author of this article has a long position in WFC