Bank Loan Putbacks & Repurchases

I mentioned this past week that I thought that Bank of America got a steal at the expense of the taxpayers. They resolved their Freddie Mac putbacks for a mere one cent on the dollar (1¢ on the  $) versus the total liability.

My back of the envelope calculations is that BofA got away with avoiding payments on somewhere between $5 billion and $15 billion dollars. Note, however, that this was not an arms length transaction. The GSEs are now wards of the state, and both the Bush administration and now the Obama team have been using them as back door bailouts for the banks.

Perhaps my assessment of this as a taxpayer giveaway is all wet, and this was a legitimate, fair value settlement. I highly doubt that is the case, but we will certainly find out soon enough: Various banks are now in discussions with other private entities who bought these securitized mortgages. The Treasury Secretary will not get to approve the giveaway, but in these cases, shareholders and private investors will. And they want every last penny that can be squeezed from their counter-parties.

These private sector, arm’s length buyers have been complaining about both the technical defects of the securitized paperwork (missing mortgage notes, improper filings, failure to properly account for the chain of ownership) as well as the substantive misrepresentations.

As an example, a pool of mortgages that might have been represented as having average borrower FICO score of 710 and LTV of 80% have in fact turned out to be 625 credit scores and 10% down payments (90% LTV). There is a direct correlation between worse scores and weaker LTVs and higher subsequent defaults.

The misrepresentations were substantial, and raise quite a few questions:

• Will the banks settle these cases voluntarily, or will they take a risk in litigation?
• Will the technical errors be perceived as significant?
• Were the substantive misrepresentations material? Did they impact the default rates?
• In dollar terms, what percentage of the putbacks can be attributed to these misrepresentations?
• What will the impact of this week’s GSE settlement be on other cases? Does this set a standard framework for future settlements, or will it be perceived as a giveaway to the banks and thus ignored?

You can think up your own questions, but these are issues that must keep corporate counsel at the banks up at night.

It will be interesting to watch the outcomes of these negotiations/litigations over the next few months . . .