As dramatic as this headline sounds, there is much less here than meets the eye. In addition, either the article that discussed this development is confused, or the underlying legal pressure is not well framed.
First, let’s get to the report, which certainly sounds serious. BusinessWeek reports that PIMCO, BlackRock, and the New York Fed are pushing Bank of America to repurchase the delinquent mortgages underlying $47 billion of bonds:
Pacific Investment Management Co., BlackRock Inc. and the Federal Reserve Bank of New York are seeking to force Bank of America Corp. to repurchase soured mortgages packaged into $47 billion of bonds by its Countrywide Financial Corp. unit.
Note several things before we go any further: first, this is NOT litigation, it’s a mere nastygram. Second, this is almost certain to be a new strategy in a effort mounted by an investor group (presumably now identified to turn up the heat on BofA) which so far has gotten nowhere. An unidentified group tried pressuring the trustee of a similar amount of bonds to direct the repurchase of loans gone bad. The trustee said it wasn’t going to do anything. So now the same line is being tried on the servicer, Countrywiide, this time alleging that it is Countrywide’s responsibility to buy back the loans.
Also observe that the argument is that the Bank of America Countrywide unit violated its servicing obligations:
Countrywide also hasn’t met its contractual obligations as a servicer because it hasn’t asked for repurchases itself and is taking too long with foreclosures, either because of document or process mistakes or because it doesn’t have enough staff to evaluate borrowers for loan modifications, Patrick said. If the issues aren’t fixed within 60 days, BNY Mellon should declare Countrywide in default of its contracts, she said.
This part verges on comical. As much as we support the idea of having more servicers do loan mods (and having an investor group push for loan mods vitiates one of the servicer excuses, that investors will protest), this legal strategy looks barmy. First, Countrywide can demand repurchases only in the case of origination defects. Even though those arguably took place, given the recent revelation in FCIC testimony that pre-sale examination of many subprime pools revealed that the a significant portion of loans fell short of the stipulated standards, that fact set does not map into a neat or lucrative legal action. This is considered to be what is called a representation and warranty breach; they are costly to fight and don’t produce large settlements because the plaintiffs have to argue their case on a loan-by-loan basis and prove each default was the result of bad underwriting, not expected losses (remember these were risky loans) or bad luck (much higher than expected unemployment). The cost of loan-by-loan analysis means any litigation is very expensive and burdensome to win.
In addition, Countrywide did not make the reps and warranties about the loans, so its liability is going to be far less than the liability of the originator. However, the legal strategy appears to be to demand Countrywide put the breached loans (assuming a breach) back to the seller and, when they fail to do that, to sue them for breach of contract.
The odds are high that Countrywide was the seller of the loans – they issued many deals themselves.
The absurdity of this strategy is that they are asking Countrywide as servicer to put the loans back to Countrywide as seller.
And the second argument, that Countrywide has been slow to foreclose, may be true but would also be a slog to prove this is Countrywide’s fault, since court dockets are jammed and foreclosure times have slowed down across all servicers.
So the thrust here seems to be to threaten to fire Countrywide as servicer. How serious a threat is this? Answer: not at all. To fire Countrywide, the investor group would need to have a replacement. Servicing mortgage pools with meaningful delinquencies (meaning just about any pool, and ones with big losses like the ones at issue are even worse) are massively cash flow negative to a servicer. Why? The servicer has to advance principal and interest to the investors when the borrower quits paying. In theory, it does so until the loan is deemed “irrecoverable”; in practice, per Tom Adams, who has spent his career in securitizations, it is until the advances equal the original loan amount. The servicer’s only way to get itself reimbursed is through foreclosures (we also believe they are dipping into other principal repayments, like refis and sales, which is not kosher).
So with it a certainty that no one with an operating brain cell would take over Countrywide’s servicing obligations unless they were paid to do so. And any such payment is contrary to the aim of the threatened action, which is to recover money for the investors.
So just because there is a litigation threat floating around a deserving target like Countrywide, don’t assume it will necessarily draw blood.