The foreclosure settlement covers how the banks treated homeowners after the housing market collapsed and it was discovered the banks often did not possess the proper paperwork indicating ownership of the home loans. Another problem facing the banks is that many loans were originated with improper or fraudulent underwriting practices. The bulk of bank originated loan ended up in mortgage backed security - MBS - pools and the holders of those securities face large losses as homes are foreclosed and sold for much less than the mortgage balances. If the banks used fraudulent practices to close more home loans, those banks may be liable for losses incurred by investors.
The next shot in the war is a lawsuit filed this week by Sealink Funding against Bank of America (NYSE:BAC), Royal Bank of Scotland (NYSE:RBS), and Deutsche Bank (NYSE:DB). The lawsuit for approximately $950 million claims the banks misrepresented the characteristics of the mortgage loans underlying the mortgage securities purchased by Sealink. The just under $1 billion claim is small potatoes - Bank of America has paid out over $30 billion in mortgage claims since buying Countrywide - to these very large banks, but a judgment against the banks could open the lawsuit floodgates, subjecting the banks which originated the mortgages or packaged the mortgage securities to hundreds of billions of dollars in claims.
Another recent news story concerns the mortgage department of Citigroup (NYSE:C) paying a $150 million fine and buying back over $1.2 billion worth of mortgages after the bank was determined to have defrauded Fannie Mae and Freddie Mac concerning home loans sold to the two government controlled mortgage funding companies. The story also notes Citigroup bought back $1 billion worth of loans in 2010. In 2011, Bank of America settled one set of lawsuits from MBS investors for $8.5 billion. A possible concern for the banks - and politicians - is the amount of mortgage securities held by large pension companies. If working people start to hear of problems with the funds set aside for their retirements, sentiment and political support may swing against the banks which sold the mortgages and securities.
The big question is how much more money do the big banking companies have at risk due to misrepresented mortgage backed securities. Bank of America - due to its 2008 purchase of Countrywide - has the most skin in the game. The company's mortgage service portfolio stands at $1.8 trillion of loan value. At the end of 2011, Bank of American had $15.9 billion set aside to cover potential mortgage repurchase claims. That amount is $10 billion larger than the amount reserved at the end of 2010. It is apparent, Bank of America sees a storm coming regarding mortgages and mortgage backed securities.
Other U.S. banks which may be at risk from mortgage securities fraud claims include the previously mentioned Citigroup, JP Morgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC). All of these banks were part of the $25 billion foreclosure practices settlement. JP Morgan Chase and Wells Fargo have less exposure to very large losses, but possible claims against the other two banks could be significant.
From an investors point of view, none of the U.S. mega-banks are very compelling as investments. As several analysts have noted, including David Rolfe - chief investment officer with Wedgewood Partners: why own any bank stocks? There are many other market sectors without these kinds of problems. The possible losses hanging over these banks from the days when they were packaging up mortgage backed securities and selling them to unsuspecting investors is too large to get a handle on. The banks may have an accurate picture of the size of their exposure and again they may be just waiting and hoping for U.S. real estate values to turn upward, reducing the amount of negative equity sitting against many billions of dollars of mortgage securities.
If large claims and lawsuits did start to go against some the banks which originally underwrote and originated the home loans backing mortgage backed securities, it would be interesting to see to what level the federal government would step in to prop up the banks. Would the feds let a bank like Bank of America go under? Fannie Mae and Freddie Mac have already taken $180 billion from the U.S. Treasury to cover mortgage loan guarantees. It is difficult to imagine the government being willing to come up with another $25, $50 or $100 billion to save Bank of America or another major financial institution.