JPMorgan Chase (JPM) and Wells Fargo (WFC) each reclassified more than $1 billion of mortgages as nonperforming loans at the urging of regulators — even though the loans are still in good shape, executives said Friday.
All U.S. banks holding similar loans are expected to make the same types of changes after four federal agencies issued guidance this year on monitoring credit quality for second liens on residential properties.
The $1.6 billion of loans reclassified by JPMorgan Chase are second mortgages that are current, but are subordinate to delinquent first mortgages, Chairman and Chief Executive Jamie Dimon said during a conference call to discuss first-quarter earnings.
"These are second mortgages that are paying behind delinquent firsts," Dimon said. "We're reserving those because we know they're going to go bad. We're just putting them in the nonperforming category before they're nonperforming."
The JPMorgan Chase loans are being reported as nonaccrual "based upon regulatory guidance issued in the first quarter," it said in a press release.
The agencies — the Federal Reserve Board, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency and National Credit Union Administration — issued the guidance on Jan. 31. It pertained to allowances for loss-estimation practices for second mortgages secured by 1-to-4 family properties.
The agencies expressed concern about banks and thrifts overstating income because of faulty revenue recognition practices.
"Placing a junior lien on nonaccrual, including a current junior lien, when payment of principal or interest in full is not expected is one appropriate method to ensure that income is not overstated," the agencies said in the joint guidance. "Consideration of these factors [should] take place before foreclosure on the [associated] senior lien or delinquency of the junior lien."
Wells Fargo reclassified $1.7 billion of performing junior-lien loans and lines to nonaccrual status, Chief Financial Officer Timothy Sloan said in a conference call. Only 12% of these reclassified junior liens were 30 days or more past due.
Nonaccrual loans increased $722 million from the fourth quarter at Wells, Sloan said.
"This policy change had an immaterial impact on our earnings since the loans were already considered in our loan-loss allowance and the related interest income impact was minimal," Sloan said. "Absent this policy change, nonaccrual loans would have been down $948 million from the fourth quarter."
When an analyst asked JPMorgan Chase's chief financial officer, Doug Braunstein, why the bank's nonperforming loans increased from the previous quarter, he hesitated. Dimon said it was "OK" to answer, so Braunstein provided the initial explanation about the second-mortgage reclassification.
The vast majority — about 88% — of the $1.6 billion in second mortgages are current, Braunstein said. But the New York bank expects they will go delinquent soon.
When first mortgages go delinquent before a second mortgage, the junior mortgage "almost always becomes a total loss" later, Dimon said.
JPMorgan Chase has a total of about $4 billion in second mortgages that are current but subordinate to a delinquent first mortgage, Dimon said. But regulators asked it to reclassify only $1.6 billion of that group. Dimon said that only $1.6 billion was moved to nonperforming because of reasons related to their loan-to-value ratio, but he did not provide a further explanation during the conference call. A JPMorgan Chase spokesman did not return a phone call seeking comment.
As a result of the reclassification, JPMorgan Chase's total nonaccrual loans increased 14% in the first quarter to $8.3 billion, from $7.3 billion a year earlier.