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As part of the Subprime Shakeout’s 100th Post (woo-hoo!), I bring you an analysis of some big, breaking news: today, the Wall Street Journal reported that Bank of America was closing in on an agreement with the investor group led by Kathy Patrick to pay $8.5 billion to settle claims over mortgage backed securities. If true, this would be the largest MBS settlement to date arising out of the mortgage crisis.
I first reported on this investor effort back in October 2010. You can find my initial take here, a link to the demand letter sent by Patrick here, and a link to the response fired off by BofA here. While we heard early in 2011 that the parties would extend all deadlines while they negotiated, we had heard very little about the progress of these efforts until today.
While the details of the purported settlement are sketchy, the WSJ report states that the current investor group includes 22 institutions, including BlackRock, PIMCO, the New York Fed, MetLife and Freddie Mac, which collectively hold $56 billion worth of mid-2000s vintage MBS. Though it did not report on any impending settlement, Bloomberg also published an article today on these negotiations, and stated that the value of the securities at issue was $84 billion, while the original principal value of the securities was $182 billion. While it is not entirely clear how these numbers line up, my best guess is that the investor group holds approximately $56 billion of the $84 billion outstanding.
What’s also unclear is how much of the reduction in the value of the bonds at issue is as a result of pay-downs and prepayments, and how much is as a result of the trusts taking losses on foreclosed properties. Thus, it is difficult to assess what percentage of potential damages from investor claims is being born by BofA under the settlement. My initial reaction is that, while the absolute dollar amount sounds large, this settlement is ultimately fairly small compared to the potential damages.
This result would be consistent with the consensus among commentators regarding this investor group, including some of the comments contained in today’s Bloomberg article and my initial take on this effort: namely, the investors involved have significant other business dealings with BofA (a.k.a. conflicts), and thus would not seek an aggressive settlement. At the same time, BofA has exhibited a growing interest in resolving its legacy RMBS liability, and thus would be interested in entering into a sweetheart settlement with a prominent group of investors that would set a precedential ceiling on future recoveries and discourage other investors from coming forward.
Without seeing the terms of the settlement and the details of the group’s holdings, it’s impossible to know what claims are being released in this settlement and how the proceeds are to be shared. For example, if the group is being paid outside of the trust waterfalls, and thus receiving the entire $8.5 billion, then the investors would actually be recovering much larger proportion of their potential damages (while potentially throwing the other investors who did not participate in the settlement under the bus, either by purporting to release their claims, or by making it impossible for those other investors to gain standing to sue).
However, sources have indicated that the settlement funds will actually be paid into the trust waterfalls. This would be ostensibly more equitable, in that all bondholders would be entitled to receive a share of the settlement proceeds, depending on their seniority. However, query how equitable it really is for a portion of the bondholders (and most likely the senior portion, since these are primarily institutional investors) to set the settlement amount for the rest of the non-participating bondholders, and to receive the lion’s share of the benefits based on their more senior bond position. Whether the investor group could or would engineer such a settlement remains to be seen.
Regardless, the fact that these investors got any money at all out of the nation’s largest bank, let alone a material dollar amount, might actually encourage other investors to come forward. A settlement of this size would reveal that BofA’s initial rhetoric, that it would fight these claims tooth and nail until they were forced to pay, was just that–empty rhetoric. For example, BofA CEO Brian Moynihan stated during the company’s third quarter 2010 earnings call that, “we will go in and fight this. It’s worked to our benefit to—we have thousands of people willing to stand and look at every one of these loans.” Further, this settlement undermines BofA’s recent estimate that the cost of its legacy RMBS putback issues would not exceed $10 billion. BofA cannot seriously assume that this is the only large investor group with which it will have to tangle over defective Countrywide loans.
The simple truth is that investors have significant amounts of viable repurchase and Securities Act claims stemming from their purchase of Countrywide-issued or originated MBS, and BofA will be forced to confront many additional claims by investors in the coming years. These additional investors might not have the same level of business dealings with BofA and thus might be willing to take more aggressive steps in pursuing reimbursement for its losses. In that case, BofA’s strategy of creating a lowball settlement to discourage investors from coming forward might end up backfiring and further eroding the already strained capital on BofA’s balance sheet.