The American judicial system is about to get a test more worthy of media coverage than the O.J. Simpson trial. It's a shame the media doesn't cover commercial litigation the way it covers sensational criminal cases. Legal experts blame mortgage legacy issues at major banks and RMBS litigation for much of the uncertainty plaguing financial markets and the economy.
Christopher Whalen with Institutional Risk Analytics pointed this out in an email to clients Thursday. "The factors making markets uneasy with respect to large financials are not going to be resolved in the marketplace," he said. Instead, Whalen said, Bank of America [stock BAC][/stock] and Wells Fargo [stock WFC][/stock] in particular "have considerable remaining issues with respect to housing and investor claims on RMBS. These matters are in the hands of the courts."
Whalen reiterates some of the thoughts espoused by attorneys attending the American Conference Institute's Residential Mortgage Litigation & Regulatory Enforcement conference in Dallas this week. Attorneys speaking at the conference noted an influx of claims tied to mortgage-backed securities and structured financial products involving mortgages.
The key question that remains is what firms or parties will end up facing the ultimate risk for losses on soured loans that were securitized and sold multiple times. They were even insured, pulling in the interest of insurance companies. It's no longer new information that banks, trustees, investors and government agencies are playing a huge game of who is going to take a haircut on the poorly underwritten RMBS deals. You have monoline insurers, such as MBIA Inc. [stock MBI][/stock], suing financial institutions like Countrywide (now BofA), saying misrepresentations made on mortgage loans under representations and warranties unfairly put the insurers on the hook for excessive risks.
The Association of Financial Guaranty Insurers went a step further in a report released in August, saying: "We estimate that these BofA repurchase obligations aggregate in the range of $10 billion to $20 billion for our industry members alone." Then you have investors, and even an attorney general's office, pushing back at the $8.5 billion proposed mortgage-backed securities settlement between Bank of America and The Bank of New York Mellon, which served as trustee on an RMBS transaction. The investors and various government agencies have weighed in on that proposed settlement, filing their own motions in court, saying the agreement fails to address the concerns of other parties. In other words, RMBS and mortgage-related securities litigation is a major issue for banks, and it's not going away anytime soon. Going back to Whalen's commentary, he said the downgrades by Moody's Investors Service of Bank of America, Citigroup and Wells Fargo this week confirms the ratings agency "provides no advance warning of substantial operational risks in these and other large cap financials."
He added "to be fair, looking at the improved bank stress index for these names, you can understand how a ratings agency could pretend that all is well looking only at the public disclosure."
Whalen explained Bank of America ranks as a 'B' on the bank stress index at the end of second quarter and Wells is rated 'A', "both up a full notch since the start of 2011. Citigroup, he noted, is still rated 'C' "because of the continued high charge-off rate, but up from 'F' where it languished for six quarters." But as Whalen said earlier, legacy legal risks are keeping the markets uneasy.
"We view BAC as requiring a receivership and WFC, C, JPM, in order of severity, as manageable with years of further pain," he said.
Whalen suggested Bank of America faces as much as $100 billion in put-back claims on Countrywide claims alone. Put-back risk is the possibility that a loan originator will have to repurchase a loan. A whole panel at the litigation conference devoted its time to discussing investor claims against servicers on loan modifications, representations and warranties, and claims tied to the securitization process. All signs point to these suits and their related settlements becoming a major issue for banks and the overall economy. One can only wonder why Casey Anthony, for example, is a more famous party in court, as RMBS have a greater impact on American lives.
Write to Kerri Panchuk.