I mentioned yesterday, when reporting on the whistleblower allegations of Bank of America defrauding HAMP, that the bank made some sort of side deal in the foreclosure fraud settlement that would deliver deeper relief to a certain subset of borrowers. What was not reported was that this will get BofA off the hook for $850 million of their obligation:

More than 200,000 financially strapped households will have a chance to sharply reduce their mortgage balances under a side deal negotiated by Bank of America Corp. that could allow the bank to avoid as much as $850 million in penalties.

Under the arrangement, part of the recent $25 billion settlement of alleged foreclosure abuses between government officials and five large lenders, Bank of America will make deeper and broader cuts in balances than other banks.

The plan will offer qualifying borrowers a chance to cut their mortgage balances to their home’s current market value. Other banks are required under the national settlement to cut principal to no more than 120% of the home’s value.

Borrowers who qualify are expected to receive principal reductions averaging more than $100,000, a Bank of America spokesman said. The pact’s total value will depend on how many borrowers take up the offer.

First of all, if this will allow the bank to avoid $850 million in penalties, then it’s no longer a $25 billion settlement. It’s now a $24.2 billion settlement. With less money devoted to principal reduction but deeper mods expected, that means that substantially less borrowers will get relief from Bank of America under the settlement. Just do the math. Earlier I reported that 200,000 borrowers would be eligible for this relief. You can bet they won’t all get it. BofA is on the hook for somewhere around $8.58 billion in principal write-downs and other potential relief (refinancing, short sales) in the settlement. At $100,000 a pop, that’s 85,000 borrowers, tops. And actually less, if $850 million gets extinguished.

But we learn in the article that the extinguishing, for BofA, will come in part from a separate Countrywide fair lending settlement with the FHA, and that most of these deep principal mods will come on those Countrywide loans, most of which are tied up in mortgage backed securities. In other words, the bank doesn’t own the loans, which are being used to pay off the settlement:

The expanded program could allow Bank of America to avoid paying $350 million in penalties tied to the foreclosure settlement and half of a separate $1 billion penalty related to a settlement of false claims filed on loans backed by the Federal Housing Administration, if the bank meets certain targets. Many of the write-downs will be made on loans originated by Countrywide Financial Corp., which Bank of America acquired in 2008, and then packaged into securities. BofA will also reduce balances on loans it owns […]

Some fund managers feel it is unfair for banks, which serviced mortgages on behalf of investors, to use those same loans to meet their obligations under the settlement. “The fact that a servicer has done a poor job has already impacted borrowers and our investors,” said BlackRock Managing Director Randy Robertson, who declined to speak specifically about the Bank of America agreement. “To ask investors to pay for banks’ fines in any form seems inappropriate and incorrect—we have very serious issues with that.”

The thinking from the regulators on this subject, I’ve learned, is that the $8.5 billion BofA settlement with their investors on MBS claims gives them leeway to change terms on those loans. It’s important to note that the BofA settlement isn’t at all final; they have so far been wrangling over the venue for the judicial sign-off to that settlement. So much of this is implied, and investors are not happy about paying for a settlement where they did nothing wrong.

However, this hasn’t risen above the level of grumbling, even though BofA will make out like bandits here. They get to shake off half of their FHA fair lending penalty ($500 million), and a fair bit of their foreclosure fraud settlement penalty ($350 million), by giving modifications on loans they don’t own. Federal officials claim that these mods will only happen where the results are “NPV positive,” or when it makes financial sense to modify the loan over allowing it to go into default. But no matter how much Shaun Donovan protests, that doesn’t change the basic notion that banks will make the decision to modify those loans, not the investors. And now there’s a material benefit for BofA even beyond getting settlement credit on those MBS; they get to reduce their total settlement obligations. Obviously, the deterrent factor for BofA, when they can get out of criminal liability by reducing the balance on someone else’s loans, is almost non-existent.

The settlement could be filed in federal court as early as today, fully one month after the announcement.

David Dayen

David Dayen