Posted on Monday, July 4, 2011
Just how much will it cost the big banks to atone for the mortgage mess?
Bank of America announced Wednesday that it would take a whopping $20 billion hit to put the fallout from the subprime bust behind it and satisfy claims from angry investors. But for its peers, the settlements may just be starting.
Heavyweight investors that forced Bank of America to hand over billions to cover the cost of home loans that later defaulted are now setting their sights on companies like JPMorgan Chase, Citigroup and Wells Fargo, raising the prospect of more multibillion-dollar deals.
“Bank of America has charted a path that our clients expect other banks will follow,” said Kathy D. Patrick, the lawyer who represented BlackRock, Pimco, the Federal Reserve Bank of New York and 19 other investors who hold the soured mortgage securities assembled by the Bank of America.
Ms. Patrick’s clients are seeking $8.5 billion from Bank of America — a settlement that needs a judge’s approval and could still face objections from investors seeking a better deal. A date to review the blueprint has been set for Nov. 17 with Justice Barbara R. Kapnick in New York Supreme Court.
All told, analysts say the financial services industry faces potential losses of tens of billions from future claims — real money even by the eye-popping standards of the nation’s biggest banks. Indeed, even that $20 billion announced Wednesday will not be enough to completely stanch the bleeding at Bank of America — it says litigation over troubled mortgages could cost it another $5 billion in the future.
The proposed settlement is more than just another financial blow to a company staggering from the collapse of the mortgage bubble. It also represents a major acknowledgment of just how flawed the mortgage process became in the giddy years leading up to the financial crisis of 2008, typified by the excesses at Countrywide Financial, the subprime mortgage lender Bank of America acquired in 2008.
Ms. Patrick and her clients claim that Countrywide created securities from mortgages originated with little, if any, proof of assets or income. Then, they argue, Bank of America did not properly service these mortgages, failed to heed pleas for help from homeowners teetering on the brink of foreclosure and frequently misplaced documents.
Most of the loans in the pools covered by the settlement were underwritten at the height of the mortgage mania: in 2005, 2006 and 2007. But with borrowers soon unable to meet their monthly payments, defaults soared.
For the banking industry, the reckoning could not come at a worse time. On Wall Street, trading revenue has been devastated by the economic uncertainty in Europe, the anemic recovery in the United States, and the stock market swoon of the last two months.
What’s more, new regulations have already taken a big bite out of profits. Despite a modest amount of relief on Wednesday, when the Federal Reserve completed new rules governing debit card swipe fees, the banks stand to lose billions when the regulations take effect next month.
If all this were not enough, further weakness in the housing and job markets has reduced lending by the banks to businesses and consumers alike, cutting yet one more source of profits.
Nevertheless, investors appeared to endorse the proposed settlement, with Bank of America shares rising nearly 3 percent, to $11.14, a move mirrored by shares of other big financials.
Some experts said the settlement could prove good news for consumers and the broader economy, speeding the foreclosure process for hundreds of thousands of homeowners while potentially making it easier to obtain modifications of existing mortgages.
By providing a template for cleaning up past claims and setting standards for future practices, the settlement could make it easier for banks to bundle and sell mortgages again, a business that has been all but dead since the financial crisis.
“That is important for providing funding for people to buy homes, grow their businesses and create jobs,” said Michael S. Barr, a former assistant Treasury secretary who now teaches law at the University of Michigan.
The accord does not resolve an investigation by all 50 state attorneys general into allegations of mortgage service abuses by Bank of America and other major lenders that could ultimately cost the industry billions more in fines and penalties. Nor does it cover liability from soured home equity loans or bonds the bank created with mortgages from lenders other than Countrywide.
Of the $20 billion that Bank of America announced Wednesday, $8.5 billion will go to investors who bought the most troubled securities backed by Countrywide mortgages. Another $5.5 billion will cover future claims by Fannie Mae, Freddie Mac and private investors that also bought troubled mortgage bonds from the bank.
The remaining $6.4 billion represents a noncash charge to reflect the drop in the value of Countrywide, as well as the increased cost of more rigorous servicing requirements and additional legal expenses.
Those charges will cause Bank of America to record a loss of $8.6 billion to $9.1 billion for the second quarter. The company, however, tried to portray the settlement as one more step in putting Countrywide’s poisonous legacy behind it, rather than a surrender.
“We did fight for the last several months,” said Brian T. Moynihan, chief executive of Bank of America, in a conference call with analysts. “But when you look at this over all, it’s a better decision for the company. It was much more adverse to the company if we kept fighting. We’ve been battling it out.”
The fight began last October when eight investors holding mortgage securities representing $104 billion in home loans spread across 115 deals charged that Countrywide and Bank of America had passed off troubled mortgage loans as safe investments, and failed to properly collect money for the investors from homeowners. Pimco and BlackRock, two of the original eight investors, had been longtime clients of Ms. Patrick’s firm, Gibbs & Bruns, and first approached the firm for help in the spring of 2010.
In early January, Bank of America announced that it had settled for $2.5 billion similar claims from Fannie Mae and Freddie Mac, the government-controlled mortgage giants. That provided valuable data for Ms. Patrick’s group to use in assessing just how many mortgages were improperly presented as safe investments or not serviced correctly.
By March, said Ms. Patrick, the group had grown to 22 firms with holdings in 530 deals that represented $424 billion in underlying mortgages.
Meanwhile, Bank of America’s stock was falling, sinking nearly 20 percent this year in part because of the fallout from the mortgage debacle, which encouraged the Charlotte, N.C.-based bank to resolve claims. Rather than just address mortgages held by Ms. Patrick’s investors, however, Bank of America decided to reimburse investors in all 530 deals — nearly all of the subprime loans that were assembled and sold to private investors on behalf of Countrywide.
The $8.5 billion settlement on $424 billion worth of mortgages suggests that 2 percent of Countrywide’s loans may have been underwritten or serviced improperly. A much bigger segment of those mortgages — about a quarter — are either in default or severely delinquent now. Bank of America attributes many of the foreclosures and defaults to the downturn in the economy.
In addition to the financial terms, the settlement also requires Bank of America to adhere to more rigorous servicing standards, on top of new requirements imposed by federal regulators.
Home loans from 300,000 borrowers will be removed from Bank of America’s servicing arm, and placed among 10 special sub-servicers, with the goal of fast-tracking a resolution of their cases. Borrowers will get answers on any possible modification within 60 days, have a single point of contact and avoid having to resubmit documents.
Now, the pressure will be on Bank of America’s main rivals to reach similar accords. JPMorgan Chase, Wells Fargo and Citigroup also face potentially billions of dollars in legal claims.
In a research note published on Wednesday, Keith Horowitz of Citigroup said the Bank of America deal was likely to set the high-water mark for other potential settlements. Using the 2 percent loss rate as a guide, he projected that Chase could face about a $9 billion hit on its portfolio of troubled mortgage bonds. Wells Fargo, Mr. Horowitz estimated, could face losses reaching $4 billion, though that could be lower because of tighter underwriting standards. Other analysts previously put Citigroup’s exposure at about $3 billion.
If that is the case, analysts say that all three of those banks appear to have set aside enough money in reserve or have the earnings power to eventually cover the cost of resolving the claims, without having to raise more capital or sell stock.
“This tells us the shape of the biggest dollar litigation settlements from the crash,” said Peter Swire, a former special assistant for housing policy in the Obama administration, and now a law professor at Ohio State University. “The doomsday scenarios for this private litigation would have threatened the solvency of the biggest banks. That risk has dropped a lot.”
By NELSON D. SCHWARTZ and ERIC DASH, THE NEW YORK TIMES, Gretchen Morgenson contributed reporting.