After several articles leaked announcing that Bank of America would settle with investors on soured residential mortgage backed securities, BofA went ahead and made the announcement. As assumed in the reports, BofA will pay $8.5 billion to a group of institutional investors to settle claims that the bank violated the representations and warranties when they sold the RMBS. They will additionally, according to their press release, “record an additional $5.5 billion provision to its representations and warranties liability for both Government-Sponsored Enterprises (GSE) and non-GSE exposures in the second quarter of 2011.” So that’s a total of $14 billion.

What’s most interesting here is that Bank of America makes this settlement with the trustee for the trusts, the Bank of New York Mellon. And they’re claiming that this will resolve almost all of their Countrywide-issued RMBS, which had an original unpaid principal balance of $424 billion.

The claim arose not from a lawsuit, but from a letter written by some large institutional investors, like Black Rock and Pimco, who argued that BofA violated the representations and warranties of the RMBS. But that did not cover every investor of every Countrywide-issued security. The trustee is taking a huge risk in representing the interests of every investor. This could open them up to exposure, if an investor believes that they didn’t get the best deal in the settlement. One experienced observer told me, “In fact, the trustees usually require investors seeking trustee action to provide indemnification before the trustee takes any actions at all. Would this mean the investor group is indemnified the trustee for any potential claims from other investors?”

If this holds, and all $424 billion is settled, that would represent 2-3 cents on the dollar. It would be a pretty raw deal for the investors, considering that Countrywide has been accused of not following procedures of conveying assets to the trusts, creating “non-mortgage backed securities.” Yves Smith has argued that these cases are incredibly hard to prove in court, but even she expected a settlement avoiding trial to cost in the range of 10-15 cents on the dollar. It seems like the bank is trying to sucker the public into believing that they are making a major concession with a giant settlement, when they would be wrapping up a lot of their legacy exposure relatively cheaply.

There are a few other issues. First, the settlement is subject to court approval. A court could simply assert that the interests of all investors are not being served by the deal. Second, the original unpaid principal balance of $424 billion does not reflect the actual value of the trusts. First of all, they admit that the current UPB is $221 billion. Second, the rest of that money will never be paid back in many cases. So the ratio is slightly better.

Third, who owns these mortgages now? Do they revert back to BofA? Do they stay in the hands of the investors? If there is an implicit acknowledgement that the RMBS were faulty, does this mean that foreclosures cannot go through?

There are some servicing improvements included as part of this deal, according to BofA:

BAC Home Loans Servicing (BAC HLS) has agreed to implement certain servicing changes, including transferring certain high-risk loans owned by the covered trusts to qualified subservicers, benchmarking loan servicing against defined industry standards regarding default-servicing timelines (with the payment of agreed-upon fees if such benchmarks are not met), and addressing certain mortgage documentation issues. The trustee and BAC HLS have also agreed, with the support of the investor group, to clarify loss mitigation standards, reflecting a shared commitment to efficient and timely procedures to assist distressed borrowers.

“Certain mortgage documentation issues.” LOL.

If nothing else, this shows that Bank of America recognizes that they had serious exposure here. They settled off of a letter, not a court case. And this is their third settlement in recent months, having settled with Fannie and Freddie on repurchase claims back in January, and a monoline insurer in April.

This should encourage other investors to pursue repurchase claims with other banks, and with BofA, because the Countrywide RMBS only represent a portion of their total. But if the banks can get off this easily, they wouldn’t balk at making these deals.

UPDATE: The settlement agreement is here. It’s in legalese, but this mainly covers representations and warranties, not necessarily securities fraud associated with these RMBS. However, some passages may indemnify BofA on those claims. Investors should sue the trustee for failing to represent their interests on this.

David Dayen

David Dayen