Legal Woes Continue to Weigh on Banks' Profits

November 12, 2014, 5:18 p.m. EST 4 Min Read

Mounting legal bills continue to eat into big banks' profits, and it's anyone's guess when chief executives will finally be able to say that their legal troubles are behind them.

More than a dozen institutions reported billions of dollars in aggregate potential legal liabilities at the end the third quarter, and some, including JPMorgan Chase and SunTrust Banks, said that their legal exposure jumped sharply from just three months earlier.

While banks have spent tens of billions of dollars to settle investigations related to the sale of faulty mortgages, probes into everything from foreign-exchange trading to subprime automobile lending are forcing many of them to continue adding to their legal reserves.

On Wednesday, Citigroup and JPMorgan and Bank of America were among six banks that agreed to pay a total of $4.3 billion to settle allegations that they tried to rig the foreign-exchange market. B of A and Citi last week revised their third-quarter earnings downward in anticipation of the settlement, while JPMorgan Chase had already included the roughly $1 billion it paid in fines in its third-quarter results.

What's unclear to investors is whether or not more settlements are forthcoming.

Bankers have been pressed to cut costs whenever and wherever possible, but legal issues continue to get in the way.

"Our expense-reduction efforts have been productive," Michael Corbat, chief executive at Citigroup, said during an Oct. 14 conference call.

"[But] we continue to face pressure related to legal costs and the need to invest in regulatory and compliance."

While settlements are expensive, drawn out legal battles can do even more damage to banks' bottom lines and their reputations, said John James, a business professor at Pace University.

"They aren't fighting these things because they want to get them out of the press as soon as possible," said James, who is also chairman emeritus of Pace's Center for Global Governance, Reporting & Regulation.

"The reputational risk and damage is too great," James said. "Management seems to have decided to just cave in, pay the fines and get it behind them."

Banks provide an estimate each quarter, in 10-Q regulatory filings, of their potential costs beyond what they've already set aside in reserves to cover legal issues. Many banks report that their pending legal issues are not expected to have a material impact on results, beyond existing reserves.

Other banks aren't so lucky. Some institutions have been dealing with the same legal issues for years, like mortgage servicing or antitrust challenges to banks' relationships with Visa and MasterCard.

The probe into foreign-exchange market manipulation was a primary culprit for Citigroup and Bank of America in the third quarter. Citigroup increased its legal provisions by an additional $600 million in the third quarter because of the investigation by U.S, British and Swiss authorities. Citigroup said in its third-quarter 10-Q that its maximum legal exposure, beyond existing reserves, remained at $5 billion, the same as the previous quarter. Citigroup continues to face several cases involving mortgage-backed securities, its Korean business unit and other matters.

Bank of America last week reported a $400 million charge in anticipation of settling foreign-exchange investigations. The charge retroactively lowered B of A's third-quarter results to a loss of 4 cents per share, from earnings of 1 cent. B of A also has numerous legal issues that are still pending, but the Charlotte, N.C., company lowered its maximum legal exposure to $3.1 billion from $5 billion in the previous quarter, according to its 10-Q.

JPMorgan's maximum legal liability swelled to $5.9 billion in the third quarter, a 28% rise from the previous quarter. JPMorgan, which has said that it faces both civil and criminal probes into its handling of the foreign-exchange market, already recorded $1 billion in legal expenses in the third quarter, primarily because of the foreign-exchange probes.

SunTrust's maximum liability rose 50% to $300 million. The $187 billion-asset SunTrust reported several developments in its ongoing legal matters in its 10-Q, including a class-action matter involving SunTrust's use of force-placed insurance. However, SunTrust did not directly link any of the developments to increased maximum exposure to legal costs.

The $386 billion-asset Bank of New York Mellon estimated that its legal exposure at Sept. 30 could be as high as $940 million, an 11% increase. A public pension fund in Brazil sued BNY Mellon in August, claiming that the bank's actions led to losses in an investment fund. BNY Mellon did not say if its higher legal exposure is a result of the Brazilian matter.

Popular in San Juan, Puerto Rico, said the top end of its legal liabilities rose 30% to $57 million. The $36.5 billion-asset Popular faces lawsuits on its practices for assessing overdraft fees.

Andy Peters writes about regional banks and community banks for American Banker.