Urban Institute: Qualified Mortgage impact overblown

Urban Institute: Qualified Mortgage impact overblown

New rules have only slightly slowed mortgage lending

WATCH: Former Wells Fargo CEO calls BofA fine “extortion”

Kovacevich says fine is political and has “nothing to do with justice”

BofA reaches $16.65B settlement over "toxic waste" mortgages

Loans date back to Countrywide and Merrill Lynch
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The BofA-GSE settlement: Were we robbed, or not?

The year started with a big surprise — the Jan. 3 announcement that Bank of America [stock BAC][/stock] had reached an agreement with Fannie Mae and Freddie Mac on "substantially" all currently outstanding repurchase requests on loans sold by Countrywide to the government-sponsored enterprises. The settlements received wide coverage. Indeed, if the Goldman-Facebook deal hadn't popped up, BofA's deal might have remained the finance story of the week until the Massachusetts Supreme Court announced its foreclosure ruling Jan. 7. Media enthusiasm for the settlement reflected the fact that BofA's stock has been pummeled for months by concerns over potential repurchase liability for misrepresented loans, mostly Countrywide originations, amplified by a host of questions about the banks' foreclosure practices and even its legal standing to foreclose on delinquent borrowers. Before the crash BAC was a $50 stock. Post-crash, and mergers with Countrywide and Merrill Lynch, it peaked close to $20 on April 15, 2010. Shares of the other huge national residential lending/servicing shops have "underperformed" on the same worries, but the markets' growing aversion to BofA bordered on Lehman-esque, taking it as low as $10.91 on Nov. 30, 2010. (Bear in mind Countrywide was the largest U.S. mortgage originator, by a wide margin, during the peak bubble years, and BofA, a distant fifth, slurped it up at the start of 2008, well before events exposed the depth of the risks Countrywide had fostered.) This price action had to distress Federal Reserve and Treasury officials. Once they slide under $10, the blood's in the water and the sharks can finish them off. You can almost hear the Federal Deposit Insurance Corp. sharpening the knives of its proposed orderly liquidation rules for no-longer too-big-to-fail banks. Under those conditions, it's hard not to imagine Treasury pushing the GSEs, via their regulator, the Federal Housing Finance Agency, while the Fed from its corner pressed BofA to adopt a more conciliatory posture toward aggrieved investors, a more positive demeanor for its investing public. But I don't — as I carefully argue here — believe they sold the taxpayers short with the New Year's surprise. Long time coming First, some background. Fears (or hopes!) that lenders could be made liable for any portion of the defaulted housing bubble loans have been growing since PLS markets collapsed in 2007, and mortgage investors began racking up massive, frequently fatal losses. Insiders and bystanders alike expected a wave of lawsuits, but they were slow to materialize. It wasn't until September 2008 that bond insurer MBIA Inc. [stock MBI][/stock] sued Countrywide and BofA, claiming Countrywide misrepresented the characteristics of loans behind bonds it guaranteed. There was more action in 2009 — a couple more bond insurers sued BofA Countrywide and two Federal Home Loan Banks sued underwriters and raters. A third FHLB launched a similar action in March 2010. In the meantime, well before the government takeover, the GSEs shifted significant human and other resources into identifying potential putbacks. In one of several fine reports on the subject ("Foreclosure-Gate: Analysis of Potential Bank Exposures," October 2010) analysts in the Royal Bank of Scotland's MBS, CMBS & ABS Strategy group illustrate rising putback volume at Freddie: from $241 million in the first quarter of 2008 to $1.4 billion in 2Q 2010. Fannie was at similar levels when it began disclosing dollar volume: $1.8 billion 1Q; $1.5 billion in 2Q. And a look at the most recent GSE quarterly filings indicates Freddie recovered $1.7 billion, Fannie $1.6 billion in 3Q 2010. It is important to recognize that not all GSE claims succeed. Freddie explains in its 3Q 2010 10Q that its contracts require the seller/servicer to repurchase within 30 days of a claim unless the lender requests an appeal, which extends the deadline. As of Sept. 30, approximately 32% of repurchase requests were outstanding for more than four months. Mortgage security analysts track this information because it has some significance for prepayments in GSE MBS. They use a range of information — the outstanding, aged and successful claims disclosed in GSE financials, delinquency statistics by vintage from Freddie and both GSEs' monthly pool-level data feeds. Given this analysis, mortgage research shops typically estimate the success rate on GSE putback claims runs around 40% to 50% (by dollar amount). Critical mass Anxiety over banks' repurchase liabilities reached a watershed in July 2010, when FHFA announced it had issued 64 subpoenas to unnamed parties for loan files related to an unknown number of subprime securities. Again, it is important to understand that putback requests for loans sold directly to the GSEs are relatively easy to assert — the guidelines are clear and the enterprises have clear rights to the loan files. No wonder that reaching a settlement over those loans was relatively easy to accomplish. Not so for loans in PLS — to demonstrate that loans in a security were misrepresented, investors generally require the loan files. Congress gave FHFA the power to subpoena this information on behalf of Fannie and Freddie. Other investors must either file a suit to obtain those files or, depending on the specific terms of each securitization, obtain 25% to 50% of investor voting rights to compel the trustee to require this information from the servicer. (Then, if you're following, the plaintiffs must go through each loan file. That's why asking the court to allow the plaintiff to examine a sample of the files has been a critical first step in a couple of pending actions.) Also in July, a group of investors represented by Dallas lawyer Talcott Franklin began petitioning trustees to act on their behalf. In early August, the investor cause received a big boost when the New York Federal Reserve Bank, which holds PLS in three holding companies, revealed it was taking steps to exercise their rights as investors in PLS and collateralized debt obligations. By September, the formation of another investor group focused on BofA/Countrywide securities and represented by Kathy Patrick, attorney at Houston law firm Gibbs & Bruns, also had become public knowledge. Over the next few weeks, names of possible members of this "super group" began to slip out: New York Fed, BlackRock, PIMCO, Freddie Mac, Metropolitan Life Insurance, Trust Company of the West, and Western Asset Management, for instance. In October, according to Reuters, the group issued "a notice of nonperformance" to Countrywide Home Loan Servicing (now a BofA unit), demanding it cure a list of issues. In the ensuing back-and-forth, BofA CEO Brian Moynihan was reported everywhere telling analysts on a conference call, "We're going to make sure that we'll pay when due but not just do a settlement to move the matter behind us." Further vows to fight the suits tooth-and-nail continued to issue from the bank in ensuing weeks. Numbers, not tweets Two reports began circulating in August that proved, one, highly influential, and two, that analysis supported by documented research, regardless of length, can impact the public thought process. These reports came from investment firms located far from Wall Street: "Mortgage Repurchases: Bank of America's Hidden Liability," subtitled "Is BAC under-reserved/under-capitalized?" by Manal Mehta, Branch Hill Capital; and "Mortgage Repurchases Part II: Private Label RMBS Investors Take Aim — Quatifying the Risks," by Chris Gamaitoni, Jason Stewart and Mike Turner, Compass Point Research & Trading. The Branch Hill report estimated BofA's potential loan repurchase liabilities at $74 billion, based on a Compass Point estimate of $21.8 billion GSE claims and its own estimate of $7.2 billion in bond insurer and $45 billion in PLS investor claims. In particular, suggested  "... that as RMBS holders organize & systematically replace servicers that previously may have had conflicts of interest, this has the potential to grow exponentially." In addition, beyond contractual claims, BofA is exposed to fraud litigation. It appears the Branch Hill report circulated privately until mid-October when it was posted on businessinsider.com as that "devastating report ... everyone is talking about." The report broke just as the foreclosure scandal was reaching its full glory, with the contention that loans had never been properly transferred to the deals in the first place going viral. Those circumstances maximized the Branch Hill report's impact on market sentiment. By contrast, the Compass Point report circulated more conventionally, with a conference call opened to the public on Aug. 31.  Its writers took a more global approach, rehashing some interesting detail from lawsuits and assessing potential liability across about a dozen top issuers and underwriters (give or take M&A impact). Worst case BofA liability would result in a $45 billion loss, 22% of book value or $2.69 a share after tax. JPM followed with $33 billion worst case losses, 19% total book value or $4.93 a share. The blockbuster came Nov. 20 with Jonathan R. Laing's Barron's weekend feature, "Banks Face Another Mortgage Crisis." The idea wasn't new; influential commentators from Chris Whalen to Felix Salmon had been saying so for some time, but Laing put Compass Point's numbers at the center of his discussion. Almost simultaneously, the Congressional Oversight Panel's November report appeared. "Examining the Consequences of Mortgage Irregularities for Financial Stability and Foreclosure Mitigation" gave further credence to the market's fears. "To put in perspective the potential problem, one investor action alone could seek to force Bank of America to repurchase and absorb partial losses on up to $47 billion in troubled loans due to alleged misrepresentations of loan quality. Bank of America currently has $230 billion in shareholders’ equity, so if several similar-sized actions — whether motivated by concerns about underwriting or loan ownership — were to succeed, the company could suffer disabling damage to its regulatory capital. It is possible that widespread challenges along these lines could pose risks to the very financial stability that the Troubled Asset Relief Program was designed to protect. Treasury has claimed that based on evidence to date, mortgage-related problems currently pose no danger to the financial system, but in light of the extensive uncertainties in the market today, Treasury’s assertions appear premature. Treasury should explain why it sees no danger. Bank regulators should also conduct new stress tests on Wall Street banks to measure their ability to deal with a potential crisis." Italics are mine. Indeed, the Treasury should explain. But I think it's too busy behind the scenes. Was it a bailout? The answer requires a careful look at the actual numbers, laid out in BofA's press release and its explanation of the settlement. First Freddie because it's simpler. As of the end of the last reported quarter, BofA faced outstanding claims on all vintages (that would be originations with first payment date before Oct. 1, 2010) sold to Freddie of $1.6 billion. Against those claims, it agreed to pay $1.28 billion cash to extinguish existing and potential claims, related to breaches of reps and warrants, on loans sold by Countrywide only through 2008. That leaves $0.32 billion presumably on the table. If we believe the MBS analysts' 50% success rate, that is a great settlement. Plus there is no reason to believe the odd $320 million won't be satisfied in the future. For instance, Freddie, in its SEC filing Jan 3, 2010, stated, "The agreement does not cover loans sold to Freddie Mac or serviced for Freddie Mac by other Bank of America entities." Moreover, BofA estimated its outstanding Freddie pipeline as of Dec. 31, 2010, all vintages and originators, AFTER the agreement is taken into account, at $0.6 billion. Whatever you may think about the bank's estimate of future liability, it seems safe to conclude that Freddie got most of what it was claiming. Now Fannie. Against a current pipeline of reps and warranties claims of $6.8 billion (as of Sept. 30, 2010, all vintages, all BofA entities), BofA paid Fannie $1.52 billion. According to the press release, that was reduced by application of certain credits, for a net cash payment of $1.34 billion (which may be why one news outlet reported a $2.5 billion deal). The agreement extinguished outstanding and potential claims on 12,045 Countrywide loans, with approximately $2.7 billion unpaid principal balance. In addition, it either resolved or extended the cure period for missing documentation-related claims on 5,750 Countrywide loans, about $1.3 billion UPB. Fannie's SEC filing, however, indicates that the agreement permits it to bring claims for any additional breaches of reps and warranties that it identifies for those 5,760 other loans. My guess is that Fannie was still up to its hips documenting claims on thousands of loans, but Treasury/FHFA pressed it to announce a partial settlement that leaves the door open for further claims when/if the docs finally do show up. According to BofA, estimated outstanding claims by Fannie remaining after the agreements amount to $2.7 billion. Think I'm a Pollyanna? Listen to the prepayment analysts. When the settlement was announced, RBS analysts compared it to their October estimates of repurchases by the four big banks. They expected BofA would satisfy GSE claims amounting to about $3.5 billion ($0.5 billion remaining in 2010, $1.7 billion 2011, $1.3 billion 2012). Accordingly, RBS analysts called the $2.8 billion settlement "in line" with their estimates. Likewise, mortgage security analysts at Barclays Capital dismissed the settlement as having more interest for equity investors than for secondary MBS markets. "There was very little effect on agency prepayments, and we do not believe that the actual losses BofA is taking are far lower than expectations." Critics, do your homework The settlements aroused much relief in the market, with many news outlets reporting BofA shares up 6% on the announcement and other banks lifted in its wake. This despite the fact that by all estimates, BofA's GSE liabilities were smaller and less uncertain than the looming private-label security put back claims, and the deal did not address objects of FHFA's subpoenas at all. Indeed the market's enthusiasm for the settlement may have exacerbated the criticism. Concerned it might "amount to a backdoor bailout that props up the bank at the expense of taxpayers," Rep. Maxine Waters (D-Calif.), a former House Financial Services subcommittee chairman, said, "The fact that Bank of America's stock surged after this deal was announced only serves to fuel my suspicion." Waters was circumspect, simply suspecting what others asserted. Mortgage News Daily ran the headline "BofA settles GSE buyback requests for pennies on the dollar." The reporter there, Jann Swanson, got the "pennies on the dollar" tag line from Tim Rood, managing director at The Collingwood Group. The headline at Fortune was more direct and asked: "Is Fannie bailing out the banks?" Relying on no apparent source, Fortune's Colin Barr groused: "But how sharp is Freddie if all it can do is squeeze a $1.28 billion payment out of a giant customer in exchange for relinquishing fraud claims on $117 billion worth of outstanding loans? The very best its million-dollar executives can do is claw back a penny on each bubbly subprime dollar?" Clearly, GSE bashing has higher value than analysis of facts (does any news outlet fact check anymore? Do editors know truth from fiction?). First, the $117 billion number comes from Freddie's SEC filing. It is not, however, the UPB of loans on which Freddie has made claims, it is the entire universe of loans originated by BofA units (including Countrywide) with first payments on or before Dec. 31, 2008, the vast majority of which are not in default and not subject to investigation for a claim. Secondly, those were not subprime dollars. It could be asserted that Countrywide's sloppy underwriting effectively stuffed subprime borrowers into prime, Alt-A and A- loans, especially in 2007 after PLS markets dried up, but "bubbly subprime dollar" is an empty rhetorical flourish, the kind of half-truth (read: half-lie) the army of fact-free commentators out there love to write. Even my favorite bank analyst Chris Whalen took a swing at it. He told Barr the settlement was a gift from Treasury Secretary Tim Geithner, cribbing from his own Reuters piece inaugurating the new year, titled "It's A Wonderful Life 2011." In his column, Whalen's text is the government's role as "catalyst for Wall Street's entirely rational exuberance." The BofA-GSE settlement is Exhibit A. Said Whalen: "If you look at the most recent quarterly earnings disclosure to the SEC from Bank of America on future losses from the GSEs, then look at the settlement with the GSEs, which was approved by the Geithner Treasury, it is hard to conclude that the settlement was not a gift." I did look. Outstanding claims by GSEs are $6.8 billion -- precisely as disclosed in BofAs conference call on the settlement -- the sum of $1.6 billion outstanding Freddie claims, $5.2 billion Fannie. Reduced, as I have described, to $2.7 billion acknowledged to be still outstanding. Not a gift, but a substantial downpayment. I am quite sure Treasury pushed the settlement. And I hope I'm not just imagining the Fed might be pressing BofA to take a more conciliatory stance toward the private-label investors' lawsuits. Everyone leaves something on the table in a settlement, but a settlement removes uncertainty for stakeholders and allows both sides to get on with business. And there is plenty of business still to do modifying, foreclosing properly and liquidating loans. The GSEs in particular benefit if they can redeploy finite staff to the task of preserving value in the growing pile of delinquent and defaulted loans repurchased from MBS on which they have no valid recourse. As a veteran GSE/bank analyst put it to me off the record, Fannie and Freddie might gain a few billion more going to the mat on reps and warranties with their current business partners, while some $250 billion or so of problems they — and the taxpayers — already own outright fall another 5 points. I'll do the math — that's $12.5 billion. Not only would FHFA and the GSEs have done this math, but the other big banks, with billions of pending claims to appeal at significant human resource expense, may also be doing it at this very moment. Linda Lowell writes a regular column, called Kitchen Sink, for HousingWire magazine. Editor’s note: Linda Lowell is a 20-year-plus veteran of MBS and ABS research at a handful of Wall Street firms. She is currently principal of OffStreet Research LLC.

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