This is the first in a series of five articles covering Bank of America's legal problems since the financial crisis. Links to the rest of the series are at the bottom of this article.
If Bank of America (NYSE: BAC ) faced death by supernova during the financial crisis, in the years since, it's been battling death by a thousand cuts. Though we're now five years past the darkest days of the downturn, the executives at B of A remain profoundly ensconced in it thanks to a seemingly endless barrage of lawsuits stemming from the ill-fated acquisition of Countrywide Financial in 2008.
Although this may sound like hyperbole, the manner in which these lawsuits play out will dictate not only when B of A fully emerges from the proverbial fog of war, but even if it completely emerges at all. Tens of billions of dollars in legal liability from these suits could still bring the lender to its knees.
What follows is the first of five articles providing an in-depth analysis of not only B of A's legal victories, which are many, but more importantly, the threats that lie ahead for the nation's second largest lender by assets.
Appreciating the scale of B of A's legal liabilities
B of A's purchase of Countrywide will go down in history as one of the worst, if not the worst, corporate acquisitions of all time. In the four years leading up to the financial crisis, Countrywide underwrote a staggering $1.562 trillion in residential mortgages. Those mortgages were then sold to government-sponsored agencies Fannie Mae or Freddie Mac or packaged into mortgage-backed securities and peddled to institutional investors like university endowments, public pension funds, and insurance companies. A full $301 billion of these loans have since either gone into default or are severely delinquent -- that is, more than 180 days past due -- and investors are now looking to B of A to make them whole.
Given the scale and multitude of legal claims brought against B of A, it's understandably hard to appreciate the progress the bank has made versus the challenges that remain. To this end, I've found it helpful to break the analysis down into three different buckets:
- Lawsuits and settlements related to the servicing of mortgages.
- Settlements related to the sale of whole mortgages to government-sponsored agencies Fannie Mae and Freddie Mac.
- Lawsuits related to the sale of mortgage-backed securities to institutional investors.
You can see this breakdown in the following infographic -- the green houses represent settled claims, and the red houses show estimates of liability remaining.
In terms of progress, the best news so far has come from the mortgage-servicing issues (the first bucket). In February of last year, the bank joined four other mortgage servicers -- JPMorgan Chase (NYSE: JPM ) , Citigroup (NYSE: C ) , Wells Fargo (NYSE: WFC ) , and Ally Financial -- in a landmark settlement with the U.S. Justice Department and 49 state attorneys general. The deal called for a total of $25 billion in cash and other relief to borrowers, with B of A's share weighing in at a whopping $11.82 billion.
Then, in January of this year, B of A joined with nine other mortgage servicers to settle similar claims brought by the Federal Reserve and the Office of the Comptroller of the Currency. Taken together, while expensive, these agreements effectively put the mortgage-servicing component of B of A's liability to rest.
B of A has also addressed the lion's share of its liability stemming from the sale of mortgages to Fannie Mae and Freddie Mac (the second bucket). Between 2004 and 2008, Countrywide sold a total of $846 billion in mortgages, or 54% of its aggregate origination volume, to these institutions. By the end of last September, a full $71 billion of the mortgages were in default, and $40 billion were severely delinquent.
In two settlements, one at the beginning of 2011 and the other at the beginning of this year, B of A paid a total of $10.08 billion (including cash and non-cash relief) to extinguish "substantially all" unresolved claims, as well as any future claims associated with loans sold to the government-sponsored enterprises. That settlement amount equates to roughly $0.09 on every dollar of the loans that were either in default or severely delinquent.
The trickiest bucket of all
The only bucket remaining, then, is the one related to Countrywide's sale of mortgage-backed securities to institutional investors. The problem is that this slice of the liability pie -- while representing only 46% of Countrywide's mortgage origination volume from 2004 to 2008 -- accounts for an inordinate share of B of A's total liability. This is because the mortgages packaged into securities were the worst of the worst, both in terms of how they've performed and the adequacy of the underlying collateral.
As noted above, of the $846 billion in mortgages sold to the GSEs, a total of $111 billion, or 13%, have either defaulted or are severely delinquent. By comparison, of the $716 billion in mortgages sold to private investors, $190 billion, or 26.5%, are similarly situated. In addition, most loans sold to the GSEs are secured by first liens, whereas many of the mortgages sold to private investors are secured by second and/or third liens.
While the amount B of A will end up owing to purchasers of Countrywide's MBSes remains a mystery, we know at least two things. First, it'll probably be a generous amount. And second, whatever the amount, it'll be a function of three different categories of cases making their way through the courts:
- BoNY breach-of-contract: A proceeding in New York in which B of A is seeking judicial approval of an $8.5 billion breach-of-contract settlement between Countrywide, 22 institutional investors, and Bank of New York Mellon (NYSE: BNY ) acting in its capacity as the trustee for $424 billion worth of MBSes.
- Insurers breach-of-contract: A handful of cases -- likewise in NY -- that concern breach-of-contract actions brought by bond insurers like MBIA (NYSE: MBI ) that insured Countrywide's mortgage-backed securities against default.
- Securities fraud: More than 20 cases in a federal court in California that address claims of securities fraud against Countrywide and an assortment of other Wall Street banks related to the sale of MBSes.
So, where does B of A stand?
If you're an investor in B of A, it probably seems like the bank will never be done paying for its ill-fated decision five years ago to purchase Countrywide. But what I hope I've demonstrated here is that the end is indeed in sight. It's just a ways off.
The bank has already put tens of billions of dollars in liability behind it with the GSE and servicing related global settlements. And by quarantining the lion's share of remaining lawsuits into only two courts -- the New York court overseeing the BNY Mellon settlement and claims by bond insurers, and the federal court in California presiding over the securities fraud charges -- B of A's legal team has positioned the bank to reach global settlements with the remaining litigants.
This isn't to say that things couldn't go awry, because they most certainly could. But the chances of that are decreasing with time.
While this may be the most pressing issue for Bank of America investors to consider, the big picture is much bigger than just the bank's legal issues. To dig in further on the banking giant, I invite you to check out our in-depth company report on Bank of America. The report details Bank of America's prospects, including three reasons to buy and three reasons to sell. Just click here to get access.
Continue reading this series:
- Part 2: One critical lawsuit that could cost B of A billions.
- Part 3: The bank needs the cards to fall in its favor to overcome lawsuits from major mortgage insurers.
- Part 4: The potential hit from securities fraud lawsuits against B of A is particularly murky.
- Part 5: Conclusion: Should Bank of America investors be fearful, or hopeful?