One of the unsettled questions from the financial crisis is whether the big banks have paid enough to cover the mortgage abuses they committed before the market collapsed.
A settlement announced Wednesday that involves Bank of America indicates that, in some cases, the banks could have been made to pay more than they have.
Bank of America agreed to pay a combined $950 million to the Financial Guaranty Insurance Company, a bond insurer, and a group of investors that includes Fir Tree Partners, a New York hedge fund. In litigation, Financial Guaranty contended that Countrywide Financial, the mortgage giant that Bank of America bought in 2008, had packaged defective home loans into bonds that were then sold to investors.
In recent months, Bank of America and other large banks have agreed to pay seemingly huge sums to settle lawsuits that contend they stuffed bonds with mortgages that fell far short of contractual standards. Last year, for instance, JPMorgan Chase agreed to a $13 billion deal over such claims.
But as large as the headline numbers might appear, some investors have voiced two chief criticisms. The settlements, they contend, effectively underestimated how many mortgages fell short of the bonds’ written standards. Also, the investors complain that they, not the banks, end up bearing some of the settlements’ costs. For instance, the big government settlements have required the banks to write down the value of the loans in the bonds to help make them more manageable for stressed borrowers. The investors bear any losses caused by such write-downs â€" not the banks.
But investors said the Bank of America deal announced on Wednesday was different.
In a statement, Fir Tree applauded the settlement, saying it provided “excellent value for bondholders.†The investors holding nine Countrywide bonds are receiving $365 million in cash from the deal. Fir Tree said that Bank of America had already made payments on seven of the nine bonds, and that it expected the remaining payments to be made within 45 days. Under other settlements, investors have had to wait for months for payment. Fir Tree said the deal was also not subject to a court approval.
Financial Guaranty received $584 million in the settlement because the company had backstopped the securities and had to make good on the bonds’ payments when the underlying mortgages soured, thus suffering losses.
Investors can measure whether a bank got off lightly in settlements or paid a high price. They take their payout and measure it as a percentage of losses suffered on the bonds.
In the Bank of America deal announced on Wednesday, the $365 million works out to 14 percent of $2.58 billion in current or estimated future losses for the nine bonds, according to a member of the investor group who was not authorized to speak publicly on the deal. This person compared the 14 percent favorably with the 6 percent figure that some have calculated for JPMorgan’s $13 billion settlement.
One reason Financial Guaranty and Fir Tree might receive a higher number is that the quality of the loans in the nine bonds might have been poorer than it was in other settlements. For example, the Countrywide deals contained second-lien mortgages, which produce higher losses than first-lien loans when they default.
Still, other investors might look at Fir Tree’s actions and feel emboldened to press on with their litigation. One of the hurdles investors face is gathering enough support to direct the trustees of the bonds to pursue litigation. To do this, bondholders typically need 25 percent of a bond’s voting rights. Fir Tree was able to amass investors with more than 50 percent of the ownership rights on the bonds, according to a person briefed on the fund’s actions. If investors had been similarly organized in the first few years after the financial crisis, they might have been able to obtain larger payments from the banks, some mortgage experts say.
Prominent mutual funds that own mortgage bonds have typically participated in private settlements that have gained payouts that some hedge funds think are too small.
While time is running out for hedge funds to file new lawsuits, several are already in the courts. Earlier this year, Nomura estimated that as many as 200 bond deals faced lawsuits that are not part of the litigation being brought on behalf of prominent investors. Those bonds could have been worth $100 billion to $200 billion at the time they were issued.
