BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

Here's Why Bank Of America's Mortgage Problem Isn't Going Away

This article is more than 10 years old.

There was a pretty scary sentence in Bank of America's third-quarter earnings presentation Tuesday.

About 31 pages into the presentation, BofA says it doesn't really know how much it will lose on demands from government-sponsored mortgage investors who are asking the bank to repurchase additional mortgage securities.

The bank warns that it is not "able to reasonably estimate the possible loss or range of possible loss with respect to GSE representations and warranties exposure."

Why? CFO Bruce Thomson explained in the bank's conference call Tuesday that Fannie Mae and Freddie Mac are asking BofA to repurchase mortgages made before 2007.  But BofA says those claims are "inconsistent with our interpretation of our contractual obligations."

This is a problem. In order for Bank of America to get back on track and regain investor confidence it needs a heavy dose of certainty in the form of a resolution for its many looming mortgage issues. While it may be nearing a resolution with state attorneys general about improperly foreclosures it seems there's no end in sight regarding repurchase claims from government sponsored entities, Fannie Mae and Freddie Mac.

BofA hasn't been sure what to expect out of the GSEs since at least the second quarter, when it warned in an SEC filing that it’s “experiencing elevated levels of new claims” from the government sponsored entities (GSEs) and that “the criteria by which the GSEs are ultimately willing to resolve claims have become more rigid over time.”

I wrote back in August that the GSEs are playing a lot harder to get more money out BofA even though the bank already paid them almost $3 billion this year including $1.35 billion for Freddie Mac and $1.52 billion for Fannie Mae.

So what's with Fannie and Freddie's reinvigorated stance on squeezing out more from BofA? It seems to be connected to a report from the inspector general of the Federal Housing Finance Agency. Back in September the agency said that Freddie Mac was essentially duped out of money in that settlement because of a faulty methodology used to come up with the settlement amount.

Here are the basic findings from that report:

  1. In mid-2010, prior to the Bank of America settlement, an FHFA senior examiner4 raised significant concerns about limitations in Freddie Mac’s existing loan review process for mortgage repurchase claims, which, according to the senior examiner, could potentially cost Freddie Mac “billions of dollars of losses.” Freddie Mac’s internal auditors independently identified concerns about the process at the end of 2010. These concerns merited prompt attention by FHFA because they potentially involve considerable recoveries for Freddie Mac and, ultimately, the taxpayers. Further, unless examined and addressed, the underlying problems are susceptible to recurrence in future settlements.
  2. FHFA did not timely act on or test the ramifications of the senior examiner’s concerns prior to the Bank of America settlement. FHFA-OIG did not independently validate Freddie Mac’s existing loan review process and, therefore, does not reach any final conclusion about it. Nevertheless, by relying on Freddie Mac’s analysis of the settlement without testing the assumptions underlying the Enterprise’s existing loan review process, FHFA senior managers may have inaccurately estimated the risk of loss to Freddie Mac.
  3. After this evaluation began, FHFA, to its credit, suspended future Enterprise mortgage repurchase settlements premised on the Freddie Mac loan review process and set in motion activities to test the concerns raised about the process. In addition, Freddie Mac’s internal auditors continued to review the issue, and on June 6, 2011, issued an audit opinion that the Enterprise’s internal corporate governance controls over this process were “Unsatisfactory.” Furthermore, at the end of 2010 and then again in mid-2011, a Freddie Mac senior manager advised the board of directors that the Enterprise could recover additional money in the future through a more expansive loan review process. Currently, FHFA and Freddie Mac are analyzing the loan review process to determine whether greater recoveries in the future are possible.

The faulty methodology missed the review 100,000 loans from 2006  the report said.  Further, 300,000 foreclosed loans that originated from 2004 to 2007 and owned by Freddie Mac were not reviewed. Those loans have a combined unpaid principal balance exceeding $50 billion, the report said.

The New York Times noted the following when the report was released:

Freddie Mac’s review process was faulty, according to the report, because it did not change its analysis to account for new types of mortgages issued during the housing boom. These included mortgages that had rock-bottom interest rates initially — known as teaser rates — lasting three years to five years before adjusting upward.

The loan review analysis used by Freddie Mac focused on mortgages that went bad within two years, because historically that had been the period during which defaults related to possible loan improprieties were most likely to occur. Reasoning that the new types of mortgages with artificially low initial rates would probably lengthen the period before large numbers of defaults occurred, the senior agency examiner urged Freddie Mac’s management in June 2010 to review loans that experienced problems well after two years, the report said.

So when BofA says the GSE's claims are are "inconsistent with our interpretation of our contractual obligations" what really seems to be happening is that the contractual obligations themselves are being re-evaluated by the GSEs. Whether or not it's too -little-too-late is a different story.