Feb 9 () - Fitch Ratings believes the federal and state settlement over alleged deficiencies in residential mortgage loan origination and foreclosure practices is a slight positive for participating banks as it caps litigation risk pertaining to these activities. The U.S. Department of Justice, U.S. Department of Housing and Urban Development, and state attorneys general agreed to terms with the five largest U.S. mortgage servicers. Settlement terms could be extended to other large financial firms, and we anticipate that additional lenders will sign on. The settlement comes after more than a year of negotiations between the various parties. Although the $25 billion headline figure appears large, the upfront costs, in the form of penalties, are more modest at around $5 billion. The bulk of the settlement will be felt in the form of increased loan modifications, including principal reductions. It will also require changes to residential loan servicing standards, which will likely increase servicing costs for participating lenders. We also think any such heightened servicing standards could also be extended to nonparticipating banks over time. Banks largely incurred their proportionate liability in 4Q11 in anticipation of this settlement. This includes the immediate cash outlays, reserves for increased loan modifications, and effects of higher servicing costs. As such, we believe the financial impact has already been felt and that this agreement, in and of itself, is not a ratings factor considering each banks' portion of the agreement and in the context of their financial standing. Although the settlement does not release banks from litigation related to potential securities laws violations (chiefly related mortgage-backed securitizations), it crystallizes potential liabilities pertaining to faulty origination and servicing practices, reducing the likelihood of extended, and likely more costly, litigation on this front. Under settlement terms, mortgage servicers in states that have opted into the deal are immune from any future state servicing and originating claims, although the federal and state governments retain the ability to press criminal charges and borrowers may still bring civil suits. Fitch also believes that this settlement potentially paves the way for broader use of principal reductions on first lien mortgages, if this proves to be successful tool in addressing borrowers unable to keep up on their mortgages. If principal reductions become more prevalent than what is required under the settlement, it would have negative implications for bank home equity loans. Fitch has and will continue to assess the implications of housing related issues on bank balance sheets. Contact: Kellie Geressy-Nilsen Senior Director Fitch Wire +1 212 908-9123 Fitch Ratings 1 State Street Christopher Wolfe Managing Director Financial Institutions +1 212 908-0771 Additional information is available on www.fitchratings.com The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.