We’ve been astonished at the continued poor reporting on the overhyped mortgage putback possible future action by Pimco, the Fed, Blackrock and others against Bank of America. Everyone seems so mesmerized by the names and the incorrect dollar size attached (the possible action relates to $47 billion of bonds, but the potential liability is much less; we penciled it out as at best $1 billion, and banking expert Chris Whalen concurred with our generally dim view of this suit).
The latest development confirms our dim view of this maybe-someday-will-be-a-case.
Let’s be clear: we are fans of sound litigation against banks. We are not fans of weak cases (and in this instance, not even yet lawsuits) being touted as asteroid-hitting-the-TARP-banks level events. First, it tends to lead possible litigants to pursue copy cat cases when they may have much better grounds for seeking redress. Second, when these cases either fizzle or drag on forever, it leads third parties to take all suits against banks less seriously, when some are on much more solid grounds.
So why is this not-even-a-case getting such undeserved attention? Remember, all putbacks are not created equal. Fannie and Freddie deals have strong putback rights written into them. The major mortgage lenders are all facing meaningful ongoing putbacks from the GSEs. So some putbacks are real and are imposing real costs on the banks. But it’s a big mistake to generalize from GSE putbacks to those under so-called “private label”, or non-GSE, deals.
The putback frenzy stems from the ought-to-be-dead monolines (remember them?) touting putback recoveries as their possible salvation. Many have booked large, as in wildly unrealistic, recoveries on their book. Those very optimistic recovery figures are the ONLY thing standing between them and being wound down. Law firms have been on conference calls with investors trying to stir interest. Hedge fund manager Mahal Mehta promoted the notion that this type of litigation has the potential to do a great deal of damage; cooler heads have deemed his claims to be sensationalistic and unsubstantiated.
But just as first impressions of people tend to stick, so to do first impressions of news stories. An important development on Friday, the release of a letter by Bank of America’s outside law firm, Wachtell Lipton, gave reason to think this threat of action might never grow up to be a real case. Yet this forceful retort received no where near the attention that the release of the initial letter did, garnering only a a short mention in the New York Times’ Dealbook (although it did provide the full text) and perfunctory coverage in Bloomberg.
Among other things, the missive took the unusual step of taking direct aim at the attorney responsible for this initiative, Kathy Patrick (“This and other troubling aspects of your letter strongly suggest it was written for an improper purpose, or to further an ulterior agenda”). She launched similar demand letter to Bank of New York, the trustee on $26 billion of Countrywide bonds. Bank of New York chose simply to ignore it and her move was deemed to be inept procedurally. (Many believe that the current letter, where the names of the investors were made public, is a reframed version of the failed BoNY effort).
The Wachtell letter makes clear that Banks of America is not lifting a finger until Patrick establishes the bona fides of her October request:
Please provide the following information for each of the 115 trusts listed in Exhibit A:
1. Identification of the specific provisions of the PSA for that Trust that were allegedly breached by Countrywide HLS.
2. Specify the factual basis for each allegation of failure to perform with respect to that Trust.
3. Identification of which Holders listed in your letter are claimed to be at least 25% holders of the Voting Rights in that Trust
4. For each Holder identified in Request No. 3: the class, certificate number, denomination, registered owner, acquisition date, and purchase price for each Certificate evidencing that Holder’s Voting Rights in that Trust.
5. For each Holder identified in Request No 3 that you claim to represent: (i) the names of the individuals who authorized the Holder’s signature on the letter, (ii), whether each Holder’s board of directors (or equivalent body) authorized the letter, and (iii) whether any controlling owner(s) of the Holder authorized the letter, and if so, the identities of the individuals who gave such authorization
Given the insinuations in the letter, and he request for proof of authorization, it appears likely that the letter is challenging whether Patrick and the New York Fed’s asset manager Blackrock, went through the proper steps to get approval from the New York Fed. Tom Adams prepared a spreadsheet of Countrywide bonds (see here for more detail) in the three Fed bailout entities managed by Blackrock, MaidenLane I, II (from Bear), and III (AIG CDOs, which may be germane if any of the CDOs are being liquidated).
Note that the total par amount of Fed bonds is $7.465 billion. Note the investor group represents $16.5 billion of bonds out out of the widely reported $47 billion, which we believe to represent face amount (the reason for referencing dollar value would be to establish meeting the 25% ownership threshold, which would be based on par value, not on purchase value). That is roughly 35% of the total. Deduct $7.465 billion, and you only have 19%, far short of the needed 25%. However, there are more than 115 issues listed on the spreadsheet (recall that the putback effort involves 115 trusts), so not all of the Fed’s deals are included in this saber-rattlings exercise, presumably because the investors collectively didn’t meet the 25% threshold. Regardless, it appears likely that the Fed inclusions was essential for at least some, perhaps a large portion, for the joint investor holdings in those 115 trusts to reach the 25% level.
MBSGuy weighed in via e-mail:
Has BofA’s law firm exposed the flaws in the investors’ demand that Countrywide repurchase billions of bad loans already?
An attorney named Kathy Patrick sent a letter to Countrywide, as servicer for billions of mortgages backing various MBS bonds, demanding that Countrywide put the loans back to the seller and alleging that Countrywide was failing as a servicer.
Ms. Patrick, thanks in large part to the impressive roster of investors, including Pimco, BlackRock (on behalf of the NY Fed), Met Life and Freddie Mac, generated a tremendous amount of media attention from her demand letter and for two weeks everyone was talking about the billions of potential exposure that banks might have due to putbacks and scrambling to understand the underlying issues and the impact on the stock prices of the banks.
The phrase “putback” is generically used to describe demands that sellers repurchase loans for purported breaches of representations and warranties made about the loans at closing. In the case of this investor group, a lawsuit has not yet been filed, but rather a demand letter was delivered as the first of several procedural steps, and challenges, the investors would have to take before they could sue the seller, or servicer. Despite the complications of such an action, and the likely years of wrangling in court, stock prices for many banks promptly dropped due to potentially adverse news, even though the outcome was far from certain. Ms. Patrick boldly proclaimed that, having served the demand letter, the clock was ticking and the servicer had 60 days before they would be held in breach of contract by the investors.
Everybody loves a good bank bashing story and this one appeared to have plenty of meat to it. So I suppose I should not be surprised that Bank of America’s response hasn’t gotten more attention. Wachtell Lipton, representing Bank of America, really rips Ms. Patrick’s letter apart. In the process, Wachtell makes a case that Ms. Patrick is in over her head and that the investor group may be getting bad advice.
I really don’t know how the Fed and Freddie got themselves involved in this, but the Wachtell attorneys are going to embarrass them at every turn. As evidence for starters, Wachtell notes the apparent irony of Freddie Mac demanding that Countrywide foreclose faster and more often when the company has publicly stated that they are “deeply committed to helping troubled homeowners keep their homes.”
The letter highlights another big issue lurking behind the potential windfall to investors in the event they are successful in forcing the seller to take back bad mortgage loans – how were investors who bought the bonds at a steep discount (Pimco comes to mind) hurt by the supposed servicing problems? The parties who were probably most damaged were who bought the bonds when they were first offered, and took the big losses. How can the Fed say it is damaged when it has repeatedly said it will make money on all of its Maiden Lane vehicles?
The Wachtell attorney effectively notifies Ms. Patrick that they clock has not started running, as she claimed when she cranked up the PR machine for her letter to Countrywide. The information requests on 115 different transactions alone could take months to put together, meaning nothing (other than a PR campaign) has started.
But then Wachtell goes on to really highlight the big issue: why was the Fed looking to sue one of its own member banks?
I am fairly certain that Wachtell would not request this if they did not already know the answer and, as a result, I suspect that they know that the board of the NY Fed did not authorize the letter. The same may apply for Freddie Mac and others in the group.
I am not a bank defender, but I really don’t like the way this whole putback issue became a sudden sensation based on such weak grounds. Given the amount of publicity the Countrywide case generated for BofA and all of the banks, one wonders if someone playing a game with this issue or trying to gain some advantage in bank stock prices?
The banks should be held accountable for the things they failed to do in the mortgage business and the fact that they are able to escape liability for the obvious and complete failure in their underwriting of mortgage loans is hugely problematic. There is no way any investor is going to come back to the mortgage market with the risk they are being asked to take, while at such an enormous information disadvantage compared to the banks.
As we indicated, this threat-to-launch-a-case was never a slam dunk, and it looks less so by the day.