Barclays estimates banks face $85 billion in mortgage reps and warranties
Major banks are struggling to size the amount of repurchase and warranty claims by private investors and government-sponsored enterprises, but overall risks to the financial system could be limited, analysts say. When a bank originates a mortgage and then sells the loan either to the GSEs Fannie Mae and Freddie Mac or to non-agency investors through securitization, those buyers can get a refund if they can prove the loans had defects that prompt mortgage default. Barclays Capital estimates over the next five to seven years, banks may end up paying $85 billion in claims, which would result in another $75 billion of more losses to come. Analysts, though, admit the math is "highly subjective" and included many assumptions, and because the claims would be paid out over time, risks of concentrated damage to balance sheets are relatively low. According to BarCap, Fannie and Freddie actively pursued these claims since 2006, and $10 billion of these claims are still outstanding at the top-four banks. Non-agency monolines are pursuing these claims as well, and individual investors are starting to gain access to loan files through formal lawsuits. In its third quarter conference call Tuesday, Bank of America (BAC) addressed the issue, citing its own difficulty in pinning down its exposure to these putbacks. In the third quarter, the bank reported a $7.3 billion loss and $872 million in rep and warranty provisions, or how much it has set aside in anticipation of refunds. The third quarter provisions nearly double the amount set aside a year ago but dropped 30% below the amount in the previous quarter. The volatile shifts in provisions concern investors and raises questions on how accurate BofA's own estimates are. BofA CEO Brian Moynihan tired to reassure those investors Tuesday. "As we get data, we'll move something forward. When we make an adjustment, we make an adjustment on exposure not on the amount of claims coming in. The danger here is that it could be lumpy," Moynihan said. He added the bank will contest any claims that lack merit. "People who said they bought a Chevy Vega and they want a 12-cylinder Mercedes, we're not going to put up with that," Moynihan said. Just because investors show a potential breach in the contracts doesn't mean the claim will be paid out. The process is slow and complex. BarCap analysts expect 15% of the agency loans in question to default and 37% for non-agency loans. The problem investors have is gaining access to the loan files, something Fannie and Freddie have an easier time of gaining, and getting individual investors to agree on costs, fees and benefit sharing would also be difficult. BofA reported $4 billion in new claims in the third quarter, down from $4.5 billion in the previous quarter but nearly double the amount a year ago. Executives said 77% of the new claims came from loans originated in 2006 and 2007. Outstanding claims at BofA stand at $12.8 billion, and 53% of those are from the GSEs. BofA approved $975 million of repurchases in the third quarter. But Moynihan said the problem is at least maintained in those problem vintages as underwriting standards at the bank improved after 2007. "The risk is sealed in this," Moynihan said. "The issue is how long the flight will take." Write to Jon Prior.