Bondholder Revenge Delayed Means $25 Billion Cost: Mortgages
For the second time in less than a week, bank investors got a reminder the companies can’t escape from bad mortgages sold during the U.S. housing boom.
A bondholder group that last year won a preliminary $8.5 billion settlement from Bank of America Corp. said yesterday it was escalating its fights with Morgan Stanley and Wells Fargo & Co. (WFC) That followed a Sept. 14 lawsuit against JPMorgan Chase & Co. (JPM) by bond insurer MBIA Inc. (MBI) that underscored how existing cases are strengthening the hands of those seeking compensation.
While the housing market is recovering after a 35 percent slump in prices from the 2006 peak, lawsuits are being filed every week as legal deadlines approach. Lenders may book an extra $25 billion or more to resolve complaints tied to mortgage debt, according to Compass Point Research & Trading LLC.
“I don’t think the banks could have recognized what they owed upfront and still remained solvent, so it doesn’t surprise me that they’ve dragged their heels” in setting aside money for the cases, saidIsaac Gradman, an attorney who consults on such litigation. “It’s surprised me that more investors didn’t more quickly take up the cause of fighting for what’s theirs.”
Eleven lenders tracked by Washington-based Compass Point have so far recognized 51 percent of the potential expenses of repurchasing faulty mortgages packaged into securities without government backing, according to a report last month by Compass Point analysts Kevin Barker and Mike Turner. That leaves about $25 billion, according to their “base-case” estimate.
In contrast, lenders have set aside almost enough for bad loans sold to government-supported Fannie Mae and Freddie Mac from 2005 through 2009. The analysts estimate 89 percent of the $43.4 billion in probable costs have already been realized.
Investors have suffered losses on mortgage securities as defaults soared amid tumbling home prices and a jump in job losses. Bondholders and insurers accuse banks of delivering debt that misrepresented risks because mortgages contained errors including inflated appraisals and overstated borrower incomes.
“We will review any communication we receive and respond appropriately,” Mary Eshet, a spokeswoman for San Francisco-based Wells Fargo, said yesterday in response to the investor group’s statement. Mary Claire Delaney, a spokeswoman for New York-based Morgan Stanley, declined to comment, as did Lawrence Grayson, a spokesman for Charlotte, North Carolina-based Bank of America. Jennifer Zuccarelli of New York-based JPMorgan, declined to comment.
The 24-company KBW Bank Index (BKX) fell 0.7 percent as of 4:19 p.m. in New York, trimming gains in the stock gauge this year to 28 percent. The companies trade at a 12 percent discount to their book value, a measure of assets minus liabilities.
Fannie Mae and Freddie Mac’s expanded efforts in the first half of this year to get refunds that reduce the size of their taxpayer bailouts boosted the cost of faulty home loans and foreclosures at the biggest U.S. banks to at least $84 billion since 2007, according to data compiled by Bloomberg.
The two companies last week unveiled policies meant to give lenders more comfort about their risks with new loans, after the Federal Reserve said the threat of so-called putbacks is causing banks to keep lending standards too tight.
The restriction in credit has been blunting Fed efforts to help the housing market by keeping borrowing costs at record lows. The central bank last week said it would buy an additional $40 billion of government-backed mortgage securities a month. Even as existing home sales climbed in August to the highest levels in two years, Chairman Ben S. Bernanke called the residential property market “one of the missing pistons in the engine” of the economic recovery.
Compass Point said that losses from so-called non-agency securities would be lower if some investors don’t assert their rights. Costs could also grow since the analysts didn’t include all banks and focused on the contractual responsibilities of lenders and bond issuers tied to their descriptions of loan quality, called representations and warranties.
Underwriters can also face separate claims including fraud cases, which, while harder to prove, can bring larger damages, said Gradman, of Petaluma, California-based IMG Enterprises LLC. In addition, Wall Street banks created collateralized debt obligations comprised of derivatives tied to housing debt.
One reason for the flurry of recent litigation is that the six-year statute of limitations for certain claims is nearing. That would include deals created before housing crashed that subsequently had the highest default rates. The new cases add to pressure on banks to set aside reserves, Compass Point said.
MBIA’s latest case against JPMorgan stems from documents the bond insurer obtained in a separate suit filed in 2010. The Armonk, New York-based firm had targeted a now-bankrupt unit of Ally Financial Inc. that issued the securities involved.
The documents showed a mortgage-review firm found in 2006 that about a third of the home-equity loans in a pool set to be included in $1.1 billion of securities failed to match the underwriting guidelines of the lender, Ally’s GMAC Mortgage Corp., or applicable laws, according to the suit.
Bear Stearns Cos., the deal’s underwriter, stripped data that showed the flaws from a spreadsheet before passing it to MBIA, the guarantor said in the suit filed in New York State Supreme Court in Westchester. JPMorgan bought Bear Stearns in 2008 as the investment bank teetered on the edge of collapse.
JPMorgan has also received mortgage-repurchase demands from Gibbs & Bruns LLP, the law firm that represented 22 bondholders including BlackRock Inc. (BLK) and Pacific Investment Management Co. that settled last year with Bank of America over securities created by Countrywide Financial Corp.
The law firm yesterday said that it issued notices of default to Wells Fargo and Morgan Stanley (MS) over $73 billion of securities. Those notices can escalate the responsibilities of mortgage-bond trustees, which investors typically must rely on to act on their behalf, or allow bondholders to sue.
While Bank of America’s deal is awaiting court approval, attorneys general from New York and Delaware have intervened to seek more information. New York has said there are “serious questions about the fairness and adequacy” of the accord, which covers just “a small fraction” of losses.
Investors have also filed new lawsuits over the past month against Citigroup Inc. (C), Goldman Sachs Group Inc., UBS AG (UBSN) and Credit Suisse Group AG. (CSGN) A spokesman for Credit Suisse said at the time the bank will “vigorously defend” itself. Spokesmen from the other banks declined to comment when the suits were filed.
That followed a slew of previous cases, including Federal Housing Finance Agency litigation against 17 banks that was filed in September 2011 over $196 billion of non-agency bonds bought by Fannie Mae (FNMA) and Freddie Mac.
In addition, a class-action suit against Goldman Sachs over mortgage securities was revived this month by a federal appeals court in New York. A three-judge panel overturned a previous ruling saying investors led by the NECA-IBEW Health & Welfare Fund, lacked standing to represent bondholders in offerings they didn’t own with similar problems.
Other legal rulings this year on the substance of cases have also gone against banks and emboldened investors, Gradman said. Issues included whether lenders need to repurchase shoddy loans even if their misrepresentations weren’t responsible for defaults, and if mortgage-bond trustees can be held liable when they don’t pursue putbacks.
Documents obtained in discovery, the exchange of evidence before trial, are ensuring that banks face a “hangover” for potentially “years to come,” said Manal Mehta, founder of San Francisco-based hedge fund Sunesis Capital, which has invested in bond insurers doing battle with banks over bad mortgages.
In a January deposition taken in lawsuits by bond insurers Syncora Guarantee Inc. and Ambac Assurance Corp., a former underwriter at due-diligence firms that were used by Bears Stearns alleged that the investment bank pushed them to find reasons to sign off on every loan, according to excerpts from a transcript submitted in court.
One case that stood out involved the amount of monthly pay listed for a so-called stated income loan from California, according to the deposition of an individual whose name was redacted. The borrower was an assistant manager at a McDonald’s Corp. restaurant.
“I believe $8,500 for someone that’s around about 19 or 20 coming out of high school was not reasonable,” the individual said. “You are not even the owner of a McDonald’s.”
That type of story ensures banks face more losses from mortgage-backed securities cases, Mehta said.
“Although MBS litigation is no longer in the forefront of news, that doesn’t mean it’s gone,” he said. “Damaging testimony from whistleblowers and other evidence collected through an exhaustive discovery process in litigation by the bond insurers is finally starting to rear its ugly head.”
To contact the reporter on this story: Jody Shenn in New York at email@example.com