The article below was written by Al Yoon and Matthew Goldstein at Reuters. Al Yoon does a great job covering the housing and mortgage markets, his commentary and perspective tends to stay a step or two ahead of most mainstream media headlines. In this case Al and Matt call attention to the fact that mortgage investors face frustration in their attempts at forcing the big bank aggregators into buying back what they consider to be misrepresented mortgage investments.
NEW YORK (Reuters) – Houston attorney Kathy Patrick represents a group of powerful mortgage investors trying to wring money out of Bank of America, but many legal experts say her chances of winning are slim.
For the second time in two months, the Gibbs & Bruns partner has sent a letter to a big bank trying to get some measure of financial relief for her clients who hold $16.5 billion of home loans packaged into bonds.
The investors say that many of the loans they bought should never have been sold to them in the first place, because they fell short of bondholders’ stated standards. They want the bank to buy back bad loans.
The bank said it is not responsible for the poor performance of the loans, and outside experts agree.
“Investors are taking a low percentage pool shot,” said Janet Tavakoli, a Chicago-based derivatives consultant who has been a long-time critic of the way banks packaged and sold mortgage bonds during the housing boom. “This will be a long drawn out process and (Patrick) could easily get stonewalled.”
If so, then bank stock investors are panicking needlessly. Bank of America’s shares have fallen nearly five percent over the last two days, on fears that Patrick and her clients, including the Federal Reserve Bank of New York and BlackRock Inc, will force the lender to buy back billions of dollars of bad mortgages.
Patrick sent her first letter in September to officials at the Bank of New York Mellon Corp, the trustee for the investment vehicles that issued the mortgage bonds, and it failed to get much attention.
Bank of New York took no formal action and Wall Street investors hardly seemed to notice.
On October 19, Patrick sent her second letter, this time to Bank of America. The letter puts the bank on notice, and if investors do not get what they want, they can declare an event of default, a prelude to suing the bank.
Even BlackRock CEO Laurence Fink, in a conference call to discuss the money management firm’s third-quarter earnings, said he thought investors had overreacted to the news about the letter. Fink didn’t confirm that BlackRock signed the letter, but he said the money manager had a fiduciary duty to do everything it can to try to protect the interests of its customers.
“From my perspective this is not as significant for the banks as some of the players believe it is,” said Fink. “I think the market reaction to bank stocks is probably overdone.”
Bank of America, as of March 31, owned about 33.8 percent of BlackRock’s capital stock, a regulatory filing shows.
Experts said it will be incumbent on investors to show that a mortgage or a bond performed poorly because it was faulty from the outset and not simply due to the poor economic conditions in the United States.
“I view this as a legal long shot,” said Paul Norris, head of structured products at Dwight Asset Management Co, and a former director of mortgage portfolios at Fannie Mae. “It’s sort of like, we tried our best and we’re going to throw one more Hail Mary. We’re going to try to get some sort of settlement out of them.”
Norris said that while working at the government-sponsored mortgage finance firm there was an effort to force banks to buy back some nonperforming loans and it was often a slog. He said another problem is often getting enough investors in a deal to stick together and agree on a legal strategy.
Patrick, for her part, said her clients are not simply making a nuisance of themselves and believe they have a legitimate claim to press Bank of America to repurchase loans that were not properly serviced or underwritten. She said her clients sent the second letter because Bank of New York declined to open an investigation into the matter.
“The Bank of New York declined to do (investigate),” she said. “So that left our clients to invoke their remedies under the pooling and servicing agreements, which they have done.”
Lenders like Bank of America are fully aware of the difficulties investors will encounter in proving their claims and are prepared for a war of attrition. That’s one reason Bank of America appears to be taking a tough line with bond investors.
“If they negotiate and settle with one, then suddenly you may be backed into a corner where you’re buying them all off,” Tony Plath, UNC-Charlotte bank professor. “This could clog up the system for the next five years.
Mid-size independent and community mortgage bankers have been fighting buyback demands from the big bank aggregators for the last two years. Remember we're not talking about new loans here, this is paper written several years ago when the housing bubble was nearing its breaking point, during the "subprime/alt-a/low doc/low credit/no credit/no doc/everybody gets a loan" era.
The most common justifications for buybacks today are the discovery that the borrower has debts that were not disclosed to the lender/investor, problems with appraisals, and overstated income. However in my experience, in most instances, buyback requests aren't ending favorably for the complaining party unless there was blatant fraud in the loan file (for example, claiming a property was the borrower's primary residence when it was not).
Counterparties, those having loans "put-back" on them, have generally been able to avoid put-backs based on appraisals and overstated income with reasoning like "the labor market tanked" and "housing prices plummeted". Plus many loan originators were smart enough to include language in their contracts about what could trigger a buyback and what couldn't. These contracts make it easier for originators to argue against buyback demands from above today, that is unless there was a blatant disregard for underwriting guidelines or fraud in the file. On top of that we cannot forget that these low doc loans were approved by automated underwriting engines or by one of the big bank aggregator's own underwriters (Fast and Easy/SISA product = perfect example). Oh and that dooesn't even include the originators that no longer exist. Ever visit ML Implode?
I shouldn't describe the counterparty process as "easy" though...buyback demands occupy a lot of time, they cannot be ignored and require specialized attention. From that perspective it will be interesting to see how the big bank aggregators deal with larger buyback requests from private investors and the GSEs.
At this point, without some form of resolution authority, we'll be dealing with fallout from foreclosure processing and loan buyback demands for years and years to come. This does not bode well for a housing recovery or an uptick in "demand pull inflation".
I went into greater detail on the sloppiness of the origination to securitization process in THIS POST