Home Loan Wholesale

Bank of America Corp.’s recent decision to provide $8.4 billion in home loan modifications to settle charges brought by state attorneys general against Countrywide Financial Corp. was hailed as a milestone when the deal was announced this fall. But apparently nobody talked to one group that will shoulder much of the settlement’s costs: investors who hold securities backed by Countrywide home loans.  Now, some of those investors are crying foul, adding to the confusion over what is becoming a central issue in efforts to resolve the wave of foreclosures that is at the root of the global financial crisis.

J.P. Morgan Chase & Co. and Citigroup Inc. recently announced foreclosure-prevention programs that aim to lower mortgage rates, extend repayment schedules and, in the case of Citigroup, reduce loan amounts, to help borrowers keep their homes. But the programs have focused primarily on home loans wholly owned by those companies because they feel they have more authority to provide loan work-outs.  Over $2 trillion in mortgage loans were packaged into mortgage-backed securities and sold to investors by Wall Street, according to Inside Mortgage Finance. But opinions vary regarding the degree to which these mortgages can be modified.  Bank of America settled charges this fall with attorneys general from 15 states. The settlement stemmed from charges that Countrywide engaged in predatory lending practices involving borrowers who took out subprime mortgages and option-ARM mortgage loans that featured a negative amortization. Under the settlement, Bank of America, which acquired Countrywide in July, agreed to modify the mortgages of as many as 400,000 borrowers by providing mortgage refinancing, lowering interest rates and reducing principal amounts. Bank of America neither admitted nor denied wrongdoing.

Background: This fall, Bank of America agreed to an $8.4 billion program to modify mortgages, to settle charges by state attorneys general against Countrywide, which it now owns.  The Concern: Many of the loans covered by the settlement were packaged into mortgage-backed securities. Some investors who own those securities say Bank of America is shifting much of the cost of the settlement to investors.  The Response: Bank of America says its contracts with investors provided it with “delegated authority” to modify many of the loans. It also is talking with investors about their concerns.

Bigger Picture: The dispute comes as mortgage companies are under pressure to do more to keep borrowers in their homes. It isn’t clear just how much authority the companies have to modify loans that were packaged into securities.  Bank of America said it owns about 12% of the roughly 400,000 loans at issue in the settlement and can modify another 75% based on the “delegated authority” provided in its contracts with investors. “We believe the program benefits both customers and investors,” a Bank of America spokesman said. Bank of America didn’t seek investor approval before agreeing to the settlement “because the design of the program was based in large part on the delegated authority” in the contracts, he added.

But some investors believe they should have been contacted first. “Our view is that Countrywide Financial Corp. made this determination without consulting with a representative group of investors,” said Ralph Daloisio, managing director at Natixis SA, which owns securities backed by Countrywide loans. He agreed, though, that if done right, loan modifications can benefit investors.  Other investors said Bank of America is moving much of the cost of the settlement to investors when it should be paying those costs itself. These investors said that they don’t oppose modifying mortgages when it will increase investor returns while keeping borrowers in their homes. But they said that many of these home loans violated representations and warranties made when the mortgages were packaged into securities. As a result, they said, Bank of America should repurchase the loans before modifying them.

“This is literally an attempt to settle a dispute with state attorneys general on predatory lending claims with someone else’s money,” said one money manager. “In 10-plus years in the market, I’ve never seen anything as outrageous as this.”  The Bank of America spokesman said that “no court has made … findings” that the Countrywide loans were “either predatory or unlawfully originated.” He said Bank of America has been “responding to investor questions regarding this program. We believe that these have been positive interactions.” Bank of America believes “the program benefits both customers and investors,” he said.  Under terms of contracts with investors, mortgage companies generally have the authority to rework loans when it is likely to benefit investors. But just how much authority the mortgage companies have is open to debate.  Mortgage loan modifications also can benefit some bondholders at the expense of others. Reducing a borrower’s loan balance, for instance, may hurt holders of the riskiest piece of a mortgage securitization more than investors who bought securities that had higher credit ratings.