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I was talking over lunch the other day with a senior executive of a large community bank that is in the midst of litigation with a rather large loan servicer that is attempting to force the bank to repurchase loans that were originated by the bank during a comparatively short-lived foray into the mortgage banking business in the mid-2000s. The loans were sold to FNMA and as readers know from my many posts on the topic, FNMA has been trying to force repurchases down the throats of loan servicers at a blistering pace. In turn, the servicers have been seeking solvent originators and trying to pass the buck back to them, where, truth be told, it belongs, assuming that FNMA has a legitimate claim.
There's the rub.
According to my lunch companion, while FNMA's auditors have scoured the loan files and found technical defects that might support a breach of warranty claim in some instances (and he wasn't conceding that point), they had yet to demonstrate that the alleged breaches caused any damages. Not surprisingly, not one loan with respect to which a repurchase demand has been made is performing, yet the servicer hasn't been able to demonstrate that the breaches relate in any way to the causes of the borrowers defaulting on the loans. The servicer's position (and I assume FNMA's, as well) is that they don't need to make that connection, they just need to show that representations or warranties have been technically breached. At this point, neither side is backing down.
As we've seen, the GSEs have been unrelenting in their pursuit of repurchase demands whenever a loan goes bad and they think they've got a snowball's chance in the Gobi of making a repurchase demand stick. They're being backed up by buyers and insurers of mortgage-backed securities that are collateralized by residential mortgage loans. Recently, the trade group that represents bond insurers sent a letter to Bank of America CEO Brian Moynihan that demands that B of A repurchase half of all residential mortgage and home equity loans that the insurers have examined and that were originated between 2005 and 2007, totaling somewhere between $10 billion and $20 billion. The trade association also demanded that regulators force the bank disclose and reserve for this potential liability. The bank refused to respond to the demand, although rumor has it that the bank will tell the trade group to do something to itself that would be impossible for most human beings, although perhaps not for Lady Gaga.
The Bloomberg article that discusses the the trade association's demand letter to Bank Of America also discusses why banks like Bank of America (or the bank my lunch companion works for) aren't simply collapsing in a heap of liquid jello when big bad GSEs and loan servicers make these demands.
Banks manage to repel about half of the buyback claims they receive by showing they’re invalid, according to Moshe Orenbuch, the Credit Suisse analyst who tabulated the bank’s losses from 2008 through the second quarter of this year. The banks probably have adequate reserves, Orenbuch said in his report last month.
It’s unlikely that “a valid defect exists for every loan repurchase request,” Bank of America said in its second-quarter regulatory filing. Even if claims are valid, losses probably would be less than the full value of the loans because the underlying real estate acts as collateral, the filing said.
“The resolution mechanism for disputes with the private insurers is a lot less developed” than with Fannie Mae and Freddie Mac, said Chris Kotowski, an analyst at Oppenheimer & Co. “There is a team of highly paid lawyers on all ends of this correspondence doing the kind of jousting that they do, hoping to draw the opponent into some legal faux pas.”
As I informed my lunch mate, while there's certainly enough money involved and potential defenses available to make this an issue worth fighting about, the ultimate winners in this Clash of the Titans would be, as they often are in the land that loves to litigate, the law firms handling both sides of the dispute. He responded that it's only fair that you pay for your thrills, and before the bank ever again decides to get into a line of business like residential mortgage banking, it will remember the pain caused by this adventure (and the legal bills will help reinforce the painful memories) and will make sure it understands all the risks that could occur if the "unexpected" happens.
I thought about telling him that they might have gotten a clue of the elephant in the room if they'd been reading my blog back in 2005, but that would have been immodest and, besides, he was picking up the check.
