Mortgage litigation: Silent storm for big banks
There's a storm brewing at Bank of America [stock BAC] [/stock], and it may be moving too slowly for policymakers and BofA leadership to catch on time, industry analysts suggest.
The big bank received startling news Wednesday when a U.S. Attorney in New York filed a $1 billion civil fraud suit over loans that Countrywide (now BofA) sold off to Fannie Mae and Freddie Mac.
The case reads like thousands of other RMBS suits, despite this case revolving around the mortgage originations process, and that's exactly what has the investment community scared. Essentially, a big nonbank firm (Countrywide) is accused of originating toxic loans that were sold off into securitization to eventually cause losses for bond insurers, investors, financial markets and the company that later acquired it, Bank of America.
And that's a significant problem for analysts like Christopher Whalen with Tangent Capital Partners. Mortgage-related litigation is hitting banks left and right. But establishing true figures for what type of loss reserves are needed is hardly a science – making it difficult to grasp the true liabilities. After all, litigation could settle, end up at the mercy of a court or simply fizzle out, but the mega banks are exposed to legacy mortgages and that reality is not going to disappear, analysts suggest.
"I think the case illustrates why (Brian) Moynihan has to go," Whalen told HousingWire. "He has refused to deal with the litigation that they are facing. If you look at the complaint, it's like the U.S. Attorney took the pleading directly from MBIA, and MBIA is winning."
MBIA, as a bond insurer, also has gone after Countrywide (BofA) in court for losses it took on mortgage investments insured by the company.
Whalen said the latest shock to BofA's vulnerable public profile is another sign from this viewpoint that the big bank needs to be restructured voluntarily.
"I think the shock is going to come from inaction," Whalen said. "The way you get ahead of this is to borrow a page from the 1930s and you deal with it. You don't pretend we don't have a problem."
Whalen's plan is for BofA's parent company to file for bankruptcy restructuring, while asking the bankruptcy court to protect the whole group so the operating units are protected. Essentially, he wants a restructuring where the bank can eventually emerge as a player in the market without facing headwinds from Countrywide's legacy mortgage issues.
Whalen notes that BofA, while linked Countrywide, is not the only bank having to evaluate RMBS on a deeper level.
JPMorgan Chase [stock JPM] [/stock] also faces a $22.5 billion suit filed by New York's AG over RMBS. And Wells Fargo was recently socked with a multimillion suit for allegedly concealing the condition of FHA-insured loans alleging that defaults unnecessarily cost the government money.
And with attorneys having a penchant for copying successful strategies and legal concepts from existing complaints, analysts are noticeably worried that Bank of America and the big banks should take notice and get ahead of RMBS litigation.
Rick Sharga, executive vice president of Carrington Mortgage Holdings, sees a pattern occurring with New York's Attorney General, and now a U.S. Attorney, filing headline capturing suits against the big banks over mortgage bonds.
"The irony here, which I hope is not escaping anyone, is that both JPMorgan and Bank of America were pressured by the government to buy these financial institutions," said Rick Sharga, executive vice president with Carrington Mortgage Holdings. "So the government that pressured them to buy these institutions is now punishing them." Multiple analysts who've studied the BofA-Countrywide transaction say while BofA's purchase became a part of the bailout, it wasn't necessarily forced to acquire Countrywide and, in the past, BofA even expressed great interest in the subprime lending giant.
"The $1 billion number seems somewhat arbitrary," Sharga said. "It seems big enough to generate press attention, but it's not big enough to threaten the bank."