The government’s litigators have already reached several multibillion-dollar mortgage settlements with big banks. But these deals have many moving parts and can be hard to evaluate.
This is once again apparent in the settlement that the Justice Department is in the early stages of negotiating with Bank of America. The bank’s shares were down more than 2 percent on Friday, after a Bloomberg News report on Thursday suggested that the government was seeking $13 billion in penalties, on top of $9.5 billion that Bank of America agreed last month to pay to the Federal Housing Finance Agency.
A combined $22.5 billion payout would be far larger than the estimates of around $16 billion that Wall Street analysts had reached after using JPMorgan Chase’s settlement with the government last year as a template.
Bank of America was always expected to pay more than JPMorgan’s $13 billion because it issued far more mortgage-backed bonds before the financial crisis. The government is taking aim at such bonds because there is much evidence that the banks stuffed them with mortgages that fell short of agreed-upon standards. Bank of America is liable for mortgage bonds that were sold by Countrywide Financial and Merrill Lynch, firms that it acquired in 2008.
The size of a final settlement with the government matters.
A higher-than-expected sum would suggest that the Justice Department had decided to be tougher on Bank of America than on JPMorgan.
But anyone hoping for that outcome may be disappointed. To see why requires understanding each of the main components of a mortgage settlement led by the Justice Department.
A substantial part of the government’s settlement is made up of money paid to the Federal Housing Finance Agency. This is meant to be compensation for selling defective bonds to Fannie Mae and Freddie Mac, the government-run mortgage entities that the agency regulates.
Another part of the settlement takes the form of consumer relief. With this, the government requires the bank to adjust mortgages to make them more affordable for borrowers. Often, the bank does not even own the modified mortgages. So any cost of the modification is borne chiefly by investors who hold the mortgages, not the banks. The government, however, likes to include that in its total settlement figure.
The third component combines payments to other federal regulators and state attorneys general, as well as penalties to the Justice Department itself.
In an analysis prepared this year by a prominent law firm for its bank clients, Bank of America’s breakdown was: $6.7 billion to the housing finance agency; $5.2 billion for consumer relief; and $5 billion in combined payments to the other regulators and enforcement agencies.
That added up to $16.9 billion, far less than the $22.5 billion implied in the Bloomberg News article.
As investors and others try to understand the bigger number, it makes sense to look more closely at the housing finance agency portion.
Bank of America’s agreement with the agency ended up totaling $9.5 billion, far higher than in the earlier legal estimates. This is because the agreement included an unanticipated type of payout, totaling $3.2 billion, that Bank of America made to Fannie Mae and Freddie Mac to buy back mortgage securities.
The argument for counting the $3.2 billion in the total settlement is that Bank of America actually had to pay cash for the securities. The argument for leaving it out is that Bank of America got the securities in return, and they may have real value and deliver profit for the bank in the future. The bank bought the bonds at around 20 percent of their original face value. The $3.2 billion is also equivalent to around two-thirds of the $5 billion in total cash flows that would come from the bonds if they were to experience no more losses, according to a person briefed on the deal.
Without the $3.2 billion, the payment to the housing finance agency falls to $6.3 billion.
The next step is to add that $6.3 billion to Bank of America’s estimated payment of $5.2 billion for consumer relief and the estimated $5 billion in payments to other government regulators. That comes to $16.5 billion, very close to the original overall estimates.
If the government ends up getting substantially more, it may then be possible to argue that it took a tougher stance with Bank of America than it did with JPMorgan.
But there is another possibility. If the government reaches a settlement with Bank of America for $16.5 billion, and that sum includes all $9.5 billion of the money that went to the housing finance agency, the Justice Department will have effectively settled for far less from the other sources. In that case, the government would have conceded significant ground.
