3 Banks Warn of Big Penalties in Mortgage Inquiries

Several big banks warned investors on Friday that they could face sizable financial penalties as a result of state and federal investigations into abusive mortgage practices.

The disclosures by Bank of America, Wells Fargo and Citigroup came after a furor late last year over how foreclosures were being conducted.

Until now, the banks have emphasized that the foreclosure controversy was mostly a threat to their reputation, rather than a financial worry. But the disclosures, made in the banks’ annual financial filings with the Securities and Exchange Commission, suggest that a settlement with the government may affect both.

State attorneys general and federal regulators began examining the servicers’ practices last fall after reports that some foreclosures were being pursued despite lost or missing documents. In other cases, employees had signed off on thousands of pages of paperwork a month, after only a cursory look.

In some cases, banks mistakenly pursued homeowners who should not have been threatened with foreclosure, while other mortgage holders reported it to be nearly impossible to reach anyone at the banks to discuss their situation.

The review also includes more basic practices, including scrutiny of whether the original loans were made properly and whether modifications of existing home loans have been done fairly.

“The current environment of heightened regulatory scrutiny has the potential to subject the corporation to inquiries or investigations that could significantly adversely affect its reputation,” Bank of America said in the filing.

The state and federal inquiries “could result in material fines, penalties, equitable remedies (including requiring default servicing or other process changes), or other enforcement actions, and result in significant legal costs,” Bank of America said.

Wells Fargo said in its filing that it was “likely that one or more of the government agencies will initiate some type of enforcement action,” including possible “civil money penalties.”

Citigroup acknowledged that federal and state regulators were investigating its foreclosure processes, which could result in increased expenses, fines and other legal remedies like a program to reduce the principal amount owed on some loans. While Citigroup has determined that “the integrity of its current foreclosure process is sound and there are no systemic issues,” it warned that it could be adversely affected by industrywide regulatory or judicial action.

Since last fall, a task force of federal bank regulators has been reviewing the foreclosure practices and internal controls of the 14 largest mortgage servicers. The examination has already identified a range of sloppy practices at all the servicers, including inadequate staffing, lax oversight of outside law firms and other vendors hired to assist with the foreclosure process, and errors with documentation.

In testimony before a Senate banking committee last week, John Walsh, the acting comptroller of the currency, which oversees national banks, said his agency and other federal regulators had ordered the servicers to take corrective actions.

“We expect that our actions will comprehensively address servicers’ identified deficiencies and will hold servicers to standards that require effective and proactive risk management of servicing operations, and appropriate remediation for customers who have been financially harmed by defects in servicers’ standards and procedures,” he said.

The banks have not yet received any formal proposals from either the attorneys general or the regulators. But a proposed settlement is expected to be ironed out in the coming weeks and then presented to the banks.

The banks are eager to put the foreclosure controversy behind them. Earlier this month, Bank of America’s chief executive, Brian T. Moynihan, said the bank was creating a special unit to hold billions of dollars in defaulted mortgages and other toxic debt.

Despite reports in recent days that a global settlement of the mortgage accusations was being floated by the Obama administration, for $20 billion or more, some bank officials and regulators expressed skepticism Friday that the eventual hit to the banks will be that high.

Indeed, many regulators in Washington are wary of too punitive a settlement for fear of hobbling their recovery just as they are turning around. Memories of the financial crisis in the fall of 2008 and the subsequent federal bailout are still vivid.

Still, even if any settlement with regulators and the attorneys general does not run into the tens of billions, the financial consequences of the housing boom and subsequent bust will haunt the banks for years. Private investors are seeking to force financial institutions to buy back tens of billions of dollars’ worth of mortgages in default, arguing the original loans were made improperly.

Over the last year, the biggest banks have set aside several billion dollars each to cover potential claims stemming both from the foreclosure mess and lawsuits by private investors holding soured mortgages.