Bank of America Corp. (BAC) may face billions of dollars more in liability for faulty mortgages if a judge agrees with insurer MBIA Inc. (MBI) that the lender must buy back loans even if the errors didn’t cause a borrower’s default.
If New York Supreme Court Justice Eileen Bransten and judges in similar cases across the country rule that the issue of “causation” doesn’t apply -- meaning it’s enough to show that the loan was improperly made -- it “could significantly impact” Bank of America’s potential costs, the bank said in a regulatory filing this month.
Such court defeats may add as much as $9 billion to what Bank of America owes bond insurers, according to hedge fund Branch Hill Capital, which is betting against its stock and has invested in MBIA. A victory for Armonk, New York-based MBIA may also strengthen claims by mortgage-securities investors that want the Charlotte, North Carolina-based bank to pay more than the $8.5 billion it’s offered them as a settlement.
“You don’t have to wait until you’re in a severe accident before you return the car with bad brakes,” said David Grais, a partner in New York at Grais & Ellsworth LLP who represents investors objecting to the bank’s proposed settlement with Countrywide Financial Corp. mortgage-bond holders.
Any ruling on the issue, which was to be the subject of a hearing today in state court in Manhattan, may come later than anticipated because the proceeding was postponed until October. The decision may intensify settlement talks between bond insurers like MBIA and other banks that issued securities based on faulty mortgages, according to the head of insurer Assured Guaranty Ltd. (AGO), which is demanding money from lenders including UBS AG (UBSN) and Credit Suisse Group AG. (CSGN)
“If they lose that case, then our certainty of getting reimbursed becomes a lot higher,” Dominic Frederico, Assured’s chief executive officer, said in an interview. Bank of America agreed in April to a deal it valued at $1.6 billion with Hamilton, Bermuda-based Assured to settle its mortgage claims.
Since the start of 2010, Bank of America’s cushion for future losses on repurchases of mortgages that never matched their promised quality has ballooned from $4 billion to $17.8 billion even as it made payments in settlements with debt guarantors such as Fannie Mae and Freddie Mac, the government- supported mortgage giants.
The bank set aside $14 billion last quarter to cover claims, including the proposed $8.5 billion for the Countrywide- bond settlement reached in June with investors including BlackRock Inc., the Federal Reserve Bank of New York and Pacific Investment Management Co. The deal is being challenged by other bondholders and attorneys general in New York and Delaware.
Its reserves and guidance on how much more it may need are based on several assumptions, though, including the company’s view that losses will only have to be reimbursed if it can be proven “that the alleged representations and warranties breach was the cause of the loss,” the bank said in the Aug. 4 filing with the Securities and Exchange Commission. If courts disagree, “it could significantly impact” the estimate of as much as $5 billion in additional liabilities.
“It could change the playing field,” MBIA Chief Executive Officer Jay Brown said on an Aug. 10 conference call with analysts and investors when asked about the causation issue. It could “have a very significant effect on the ability to rescind or obtain rescissionary damages,” he said. “So, it can affect the view of both parties as to the likely outcome of the trial.”
Lawrence Grayson, a spokesman for Bank of America, said in an e-mail that Branch Hill Capital “consistently has overstated Bank of America’s representation and warranty repurchase exposure.”
“Their motives are not nuanced,” he said. “Less than a year ago, they had estimated repurchase losses for Bank of America of approximately $74 billion. They were wrong then, and we believe that they are wrong now.”
The company has provisions for all exposure that “currently is probable and reasonably estimable,” he said.
In December, Bransten denied Bank of America’s bid to prevent MBIA from using reviews of samples of loans in the case, rather than requiring reviews of every individual mortgage in dispute. The ruling may add to the threats facing Bank of America by encouraging suits, according to the SEC filing.
‘Resources to Deploy’
Bank of America Vice Chairman Charles H. Noski said on an October conference call that the bank had the “resources to deploy” in “defending the interests of our shareholders” through loan-by-loan fights. On the same call, he sought to reassure investors that its losses would be minimized by contract language specifying when the lender would be required to repurchase faulty loans.
“Many of the losses observed in these deals have been, and continue to be, driven by external factors, like the substantial depreciation in home prices, persistently high unemployment and other economic trends, diminishing the likelihood that any loan defect, assuming one exists at all, was the cause of the loan’s default,” said Noski, then the bank’s chief financial officer.
Countrywide, the top-ranked mortgage lender acquired by Bank of America in 2008, agreed to buy back loans when a misrepresentation on loan documents “materially and adversely affects the interests of the noteholders or the note-insurer in those mortgage loans,” according to a prospectus for one of the 2006 deals involved in the MBIA case.
Merrill Lynch & Co., which Bank of America bought at the beginning of 2009, promised loan repurchases when a misstatement “adversely and materially affects the value of the related mortgage loan, prepayment charges or the interests of the certificate holders,” according to a 2006 bond agreement.
Only a handful of cases, almost all involving commercial properties, have dealt with what such language means for breach- of-contract claims. In those cases, courts reached decisions with differing implications, said John Doherty, a lawyer in New York with Atlanta-based Alston & Bird LLP.
Doherty, whose firm’s clients include Bank of America, said both sides in loan-repurchase fights have reason to believe they are right on whether proof of loss causation is necessary. Contracts citing “the interests of noteholders” may be better for debt sellers than those referencing the “value” of loans, he said.
Both types of language should be read as referencing whether the loans would have been worth as much at the time of the bond deal, if properly described, according to lawyers including Grais, whose clients include Federal Home Loan Banks and anonymous investors objecting to the Countrywide settlement.
In thinking about whether a misrepresentation led to a default, courts may consider the fact that without faulty data, “the loan wouldn’t have closed, or maybe would have closed but at a smaller loan amount and thus a lesser loss” said Richard Barrent, president of Urbandale, Iowa-based Barrent Group, which reviews defaulted mortgages for bondholders and insurers.
Mortgage-seller lawyers point to a case in federal court in Dayton, Ohio, involving commercial-mortgage securities, Wells Fargo & Co. and Bank of America’s LaSalle Bank unit.
In a 2009 order, the court said “the fact that an investor might have made a different decision had he or she had different information may make that information material to the investor’s decision, but it does not make the omission of that information cause a material and adverse effect on the loan.”
Doherty said “when you start to have some uniformity in court decisions on these points, you’re going to see how these things shake out.”
Bank of America shares have declined 44 percent this year through yesterday, leaving the stock 63 percent below its stated book value amid investor concern that the lender’s mortgage liabilities will continue to mount. Its shares fell 45 cents, or 6 percent, to $7.01 at 4 p.m. in New York Stock Exchange composite trading.
The cost to protect against a default by the bank soared this month as investors flocked to credit-default swaps to guard against market losses on the lenders’ debt. Five-year swaps on Bank of America climbed to as high as 370 basis points last week and traded at 330 basis points as of 3:57 p.m. today in New York, according to prices from broker Phoenix Partners Group. The contracts are up from 177.5 basis points at the end of July.
Bank of America swaps last week reached the widest-ever compared with peers including JPMorgan Chase & Co. and Citigroup Inc. The average credit swap for the six biggest U.S. banks was 190.5 basis points yesterday, according to data provider CMA.
Bank of America needs to set aside between $10.6 billion and $44.4 billion more to cover losses on soured mortgages sold to or insured by others, said Chris Gamaitoni, a Compass Point Research and Trading LLC analyst.
MBIA’s lawyers at Quinn Emanuel Urquhart & Sullivan LLP are also arguing that insurance law should allow it to win against Bank of America on breach-of-contract and fraud claims without proving causation.
The causation issue alone may add $8 billion to $9 billion of liabilities from bond insurers, said Manal Mehta, a partner at Branch Hill Capital in San Francisco.
“That is probably as important as the statistical sampling ruling,” Mehta said. “It would take away one of Countrywide’s key defenses and significantly accelerate the timetable for litigation.”
Hard to Assess
Bank of America’s ultimate liability is difficult to assess because the matter is likely to be settled, said Jonathan Hatcher, a credit strategist at Jefferies Group Inc. who covers financial companies.
Bank of America is among lenders suing MBIA to overturn a 2009 split of the insurer that the bank said left the unit guaranteeing mortgage bonds insolvent.
“The whole thing is literally a negotiation,” Hatcher said of the multiple threads of litigation. “That makes it difficult to assess what the number would be.”
Bank of America, in its talks with 22 of the world’s largest debt investors, argued that any loan repurchase would require loss causation be proven, according to a filing in New York state court of an expert opinion by Brian Lin, a managing director at RRMS Advisors. Those negotiations led to the proposed $8.5 billion settlement.
Lin said a settlement between $8.8 billion and $11 billion would be reasonable, relying in part on an assumption that investors would be successful in getting Bank of America to repurchase only 40 percent of misrepresented loans. The investor group had argued that they thought a success rate of 50 percent to 75 percent was more reasonable, according to his opinion filing.
Lin was hired by Bank of New York Mellon Corp., the bonds’ trustee that is seeking approval for the accord, to provide the assessment, in which he said he didn’t take into consideration Bank of America’s views on causation in his calculation. He declined to comment.
If a loan was missing title insurance, it’d make no sense to say that it shouldn’t be repurchased because a borrower defaulted after losing his job, said Jonathan C. Wishnia, a lawyer at Lowenstein Sandler PC in Roseland, New Jersey, who represents investment firms and loan servicers. The foreclosure loss could be larger even if not caused by the mistake, he said.
Wishnia added that the outcome of the litigation may still depend on the details of the contracts -- and how those may be interpreted by the courts is unclear because such cases usually settle out of court.
“That’s historical model, these things didn’t get litigated that often,” he said.
The case is MBIA Insurance v. Countrywide Home Loans, 602825-08, New York State Supreme Court (New York County).