PNC Financial Services Group Inc. (PNC) plans to boost its residential mortgage repurchase reserves by around $350 million in the second quarter of 2012. The decision follows the company’s experience of recently elevated levels of government sponsored enterprise (GSE)-related repurchase demands. The company has conveyed this information to investors at Morgan Stanley‘s (MS) financials conference yesterday.

The increased levels of GSE-related repurchase demands for PNC Financial are primarily in 2005-08 vintages and the major reasons cited for the recent claims include property values and missing documentation. The reserve additions will result in life-to-date accrued losses of $1.6 billion.

The GSE, whose name was not being referred by the PNC Financial management, insists on demanding mortgage repurchases by PNC Financial. The mortgages are mostly originated by National City Corp. which was acquired in 2009.

It was found in the aftermath of the real estate market collapse in 2008 and the financial crisis that mortgage and mortgage backed securities occupied a significant share of the total financial system. In several situations, the legitimacy of the mortgages as well as the documents was doubtful. The mortgage originators did not complete due diligence in several cases and also deliberately defrauded.

Now when banks sell mortgage-backed securities to investors and GSEs, there is a clause that can force a bank to buyback the securities in the event of fraudulent or faulty underwriting or origination of the underlying mortgage. Therefore, in cases of fraudulent and faulty origination documents, the holder of the mortgage-backed securities demands buybacks by the seller of the security.

In fact, a number of Wall Street Big banks have suffered billions of losses for costs associated with such activities. Besides PNC Financial, Bank of America Corp. (BAC) is also experiencing increased demands for mortgage repurchases from the GSEs. The mortgages originated primarily from Countrywide Financial which Bank of America had purchased in 2008.

For PNC Financial, an increase in mortgage repurchase demand remains a concern.Moreover, a tepid economic recovery, continued low interest rate environment and regulatory issues seem to somewhat limit growth in the company’s profitability.

However, the continued strengthening of the balance sheet should propel its earnings ahead. Moreover, strategic acquisitions in the recent times should also help in generating revenue growth. Stress test clearance, dividend hikes and share buybacks also serve as positive catalysts for the stock.

PNC Financial shares maintain a Zacks #3 Rank, which translates into a short-term Hold recommendation. Considering the fundamentals, we also maintain our long-term Neutral rating on the stock.

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