Bank of America Corp., battling demands for almost $13 billion of refunds from mortgage investors, reported that the fastest-growing group of claims involves loans to people with the best credit scores.
Claims for refunds on prime mortgages surged 150 percent to $3.6 billion in the first nine months of 2010, the Charlotte, North Carolina-based bank said last month in its quarterly report. Claims on subprime loans, made to borrowers deemed more likely to default, were little changed at $579 million. Mortgage investors can demand refunds from a bank if a loan was based on faulty data about the home or borrower.
Overdue prime mortgages set a record this year, opening more loans to scrutiny for defects that could entitle investors to a buyback. The Congressional Oversight Panel said last month that too many repurchases could rattle the financial system, and Bank of America’s stock dropped 27 percent this year through yesterday, partly on concern that $4.4 billion of reserves stockpiled to cover such costs won’t be enough.
“It was just a very sloppy process” that wasn’t confined to subprime loans, said David Havens, an analyst at Nomura Holdings Inc. in New York. “Overlooking bits and pieces of the underwriting process can come back to hurt you, because investors sold a faulty bill of goods want to recover losses.”
The ultimate cost to the industry could range from $54 billion to $106 billion, according to a Nov. 29 report from Paul Miller, the banking analyst at FBR Capital Markets.
The jump in refund claims, mostly from Fannie Mae and Freddie Mac, may signal that repurchases tied to prime loans will spread to the rest of the industry, according to Christine Clifford, vice president of Access Mortgage Research & Consulting Inc. in Columbia, Maryland. With the U.S. jobless rate stuck above 9 percent for 18 months, more of the most creditworthy borrowers will miss payments, she said.
“When there is a default, Fannie and Freddie are more likely to audit the loan,” said Clifford, a 27-year veteran of the business. “This is a big problem and I don’t think it’s contained.”
Bank of America, the biggest by assets in the U.S., is the only firm among the top four home lenders to disclose the credit quality of loans tied to the refunds, also called putbacks. Chief Executive Officer Brian T. Moynihan said on Nov. 4 that any losses will be “manageable through earnings in the next couple of years.”
Putback claims on prime loans are surging because of stepped-up demands from Fannie Mae and Freddie Mac, the government-owned mortgage companies, which buy mostly prime loans, according to Thomas Lawler, a former portfolio manager at Fannie Mae and now an economic consultant. Investors in so- called private-label mortgage securities, which are backed by a greater percentage of lower-rated loans including subprime, haven’t been as successful. That may change if the investors get better organized, Lawler said.
When banks sell mortgages to investors or bundle them into securities, they typically offer “representations and warranties,” in which they guarantee that information backing the loans is accurate. Examples include borrowers’ income and the appraised worth of the home. If the data is proven wrong, the bank may buy back the loan or reimburse investors for the lost value.
Moynihan, 51, said last month that the bank was engaged in “hand-to-hand combat” to fend off buyback demands from Fannie Mae and Freddie Mac as well as bond insurers and private investors who also want to return loans to the company.
Pending putback claims rose to $12.9 billion by Sept. 30 from $7.7 billion at the end of 2009, Bank of America said. Requests from Fannie Mae and Freddie Mac on loans created in 2007, at the peak of home prices, fueled much of the rise as those mortgages had higher delinquency rates, the bank said.
Prime loans made up 28 percent of outstanding claims at Sept. 30, compared with 19 percent at the end of 2009, according to the Bank of America filing. Demands tied to loans that were deemed Alt-A, a designation in between prime and subprime, climbed 74 percent to $3.5 billion. Claims on home-equity loans rose 50 percent to $3.4 billion, while demands linked to “pay option” loans, in which borrowers can typically choose to make smaller initial payments than with fixed-rate mortgages, expanded 24 percent to $1.4 billion.
In addition to the $4.4 billion already reserved, Bank of America has said it expects to set aside about $500 million each quarter to cover valid claims for the next few years. The industry probably will be fully reserved for putbacks by the end of 2012, JPMorgan Chase & Co. analysts led by Kian Abouhossein said in a Nov. 12 note.
More than half of the claims at Bank of America stem from mortgages created by Countrywide Financial Corp., acquired in 2008, said Jerry Dubrowski, a spokesman for the bank. The demands are mostly tied to loans made from 2004 to 2008, when the industry’s underwriting standards were more lax, he said.
“You had a lot of limited-documentation loans from Countrywide that were classified as prime but weren’t really prime products,” said Christopher Thornberg, principal at Beacon Economics LLC in Los Angeles. “Just because you were prime from a credit standpoint doesn’t mean you were being truthful about other parts of your credit profile.”
The lender is examining every disputed mortgage to determine why it soured and whether the firm is at fault, Dubrowski said. The bank will “act responsibly” and repurchase the loan in cases where there were valid defects, he said.
“The question becomes, what led to that loan not performing as expected?” Dubrowski said. “Was it the economy? Did the person lose his or her job and stop making the payments? Was there some external event that triggered that loan to stop performing, or was it an underwriting or documentation defect?”
Bank of America’s $12.9 billion in claims represents the unpaid principal balance of mortgages where a buyback demand is pending. Actual losses typically have been smaller because some claims turn out to be invalid, according to a Bank of America presentation to investors on Nov. 4. Even among loans that are repurchased after defects are found, losses can be trimmed by seizing the collateral.
To illustrate the point, the bank said cumulative claims from government-sponsored enterprises on $1.2 trillion of mortgages originated from 2004 to 2008 have amounted to $18 billion. Of those claims, $11.4 billion were resolved, with losses totaling $2.5 billion as of Sept. 30. Bank of America estimated it’s about two-thirds of the way through the claims it will ultimately receive from the GSEs.
Janis Smith, a spokeswoman for Washington-based Fannie Mae, and Michael Cosgrove of McLean, Virginia-based Freddie Mac declined to comment. Fannie and Freddie don’t detail putback requests by credit quality.
Fannie Mae and Freddie Mac, created by Congress to boost U.S. homeownership by buying mortgages, were seized in September 2008. With more than $150 billion in taxpayer funds already spent on bailing out the two firms, lawmakers are pressing them to shift more of the burden back to the banks that created defective loans.
In an August letter to President Barack Obama, Representative Barney Frank, the Massachusetts Democrat who leads the House Financial Services Committee, said the battle to get refunds “should be fought with every tool.”
Pacific Investment Management Co., BlackRock Inc. and the Federal Reserve Bank of New York are seeking to force Bank of America to repurchase soured mortgages packaged into about $47 billion of bonds by Countrywide, people familiar with the matter have said. Bond insurers including MBIA Inc. have turned to lawsuits to seek recovery from lenders.
The industry’s losses from putbacks may total about $52 billion and will be borne mostly by Bank of America, JPMorgan Chase, Wells Fargo & Co. and Citigroup Inc., according to a Nov. 16 report from the Congressional Oversight Panel. The four banks have already booked $11.4 billion in costs and reserved a total of about $10 billion for coming expenses, the panel said.
Prime putback demands probably increased at Bank of America’s rivals because Fannie Mae and Freddie Mac are the main source, said Mark Calabria, director of financial-regulation studies at the Cato Institute, a policy research group in Washington. Tom Kelly of JPMorgan, Vickee Adams of Wells Fargo and Mark Rodgers of Citigroup declined to comment.
Rising defaults and their potential to create more putbacks caught the attention of the Congressional Oversight Panel, which said in its report that Bank of America could suffer “disabling damage” to its capital if reserves are inadequate. Bank of America got $45 billion in U.S. bailouts during the financial crisis, which has since been repaid, and Moynihan said when he accepted the CEO job last year that his goals include ensuring the bank will never again need government help.
The panel, whose mission is to monitor financial markets and regulators, said the U.S. Treasury Department “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.”