Banks and Investing and Opinion and Investing Column and Banking & Finance

SKARBECK: Big banks still face issues over soured mortgages

January 22, 2011

Ken SkarbeckThe U.S. banking system continues on its path toward healing—with many thanks to the ongoing generosity of U.S. taxpayers. Recent quarterly earnings reports showed the mega-banks were in the green by the billions of dollars.

Now apparently flush with cash, bank CEOs are itching to raise their dividends. To facilitate their desire, the Federal Reserve recently undertook another round of bank stress tests to determine if capital levels are strong enough to allow banks to increase dividends or repurchase stock.

Industry analyst Chris Whalen of Institutional Risk Analytics has described these stress tests as a marketing exercise by the Fed on behalf of its “clients,” the banks. He believes that none of the eight top banks should be allowed to raise their dividends this year if regulators are at all paying attention to the mortgage-servicing and securitization mess.

Demonstrating his concern is the recent court decision in what is known as the Ibanez foreclosure case, which has sent shivers through the banking industry. On Jan. 7, the Massachusetts Supreme Judicial Court ruled that Wells Fargo and U.S. Bank wrongfully foreclosed on two properties owned by Antonio Ibanez. That the mortgages were in default was not in dispute. Instead, the court said the banks failed to show that the mortgages had been assigned to them at the time of foreclosure.

The original Ibanez mortgages were sold a couple of times, and were even purchased by now-defunct Lehman Brothers Holding before becoming part of a 1,220-mortgage securitization pool with U.S. Bank as trustee. However, when the mortgages were securitized, the assignment on the note was left blank.

Aside from this court decision exposing an industry problem with assignment errors, when a bank sells a mortgage to investors or bundles them into securities, they typically offer “representations and warranties” guaranteeing that the information backing the loan is accurate. If the data is proven wrong, the bank may be required to buy back the loan or reimburse investors for the lost value.

While analyst Whalen doubts that homeowners will win widespread loan forgiveness as a result of errors in assignment, he argues that investors in mortgages facing losses of hundreds of billions of dollars will exercise their warranties and “put-back” securities where the note was either not delivered or done in a negligent way. He believes investor claims to put-back soured bonds could devastate some of the top banks.

Consider that PIMCO and Blackrock, two huge investment management firms, are seeking to force Bank of America to repurchase $47 billion in soured mortgage bonds sold to them by Bank of America’s Countrywide Financial unit.

In an attempt to quickly address these put-back clauses, on Jan. 3, Bank of America paid $1.5 billion to Fannie Mae to end claims on $4 billion of bad loans and $1.3 billion to Freddie Mac to resolve claims on $127 billion in mortgages. However, lawmakers are questioning these settlements and want regulators to investigate whether these payments “represent the real liability the enterprises bear” on the soured loans. Because after all, as you recall, the taxpayers own Fannie and Freddie and are the party seeking fair settlement.

To no surprise, Whalen claims the settlements being negotiated between banks and Fannie Mae are clearly a gift to the banks and that taxpayers are getting the raw end of the deal.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.

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