A U.S. regulator sued a number of major banks on Friday over losses on more than $41 billion in subprime mortgage bonds, which may hamper a broader government mortgage settlement with banks. The lawsuits by the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, came as a surprise to the market and weighed on bank shares.
The lawsuits could add billions of dollars to the banks' potential costs at perhaps the worst possible time for the industry.
The FHFA accused major banks, including Bank of America Corp, its Merrill Lynch unit, Barclays Plc, Citigroup Inc and Nomura Holdings Inc of selling bonds backed by mortgages that should have never been packaged into securities.
The biggest banks are already negotiating with the attorneys general of all 50 states to address mortgage abuses. They are looking for a comprehensive settlement that will protect them from future litigation and limit their potential mortgage litigation losses.
"This new litigation could disrupt the AG settlement," said Anthony Sanders, finance professor at George Mason University and a former mortgage bond strategist.
Banks may be more reluctant to agree to a settlement if they know litigation from other government players could still wallop their capital, he said.
Before the FHFA lawsuits had even hit a court docket, financial experts offered blunt expectations for the outcome.
"The lawsuits will be settled. The end result will be a further outflow of cash from the banks, and more importantly an additional black eye," said Sean Egan, managing director of Egan-Jones Ratings Co.
FHFA director Edward DeMarco is looking to minimize future losses for Fannie Mae and Freddie Mac, which are owned by the government after failing in 2008. The firms are pillars of U.S. mortgage finance.
The KBW Bank Index closed down 4.5 percent, nearly doubling the losses of the broader market. Bank of America led the index lower, dropping 8.3 percent.
Bank shares also came under pressure from signs that the Federal Reserve could start selling shorter-term debt on its books and buying long-dated bonds to push longer-term yields lower as a stimulus measure.
Such a move, known as "operation twist," would hurt banks whose profit margin is tied to the short-term rates at which they fund and the longer-term rates at which they invest.
