Fannie Threatened to Block B of A Asset Sales to Settle Mortgage Battle

Fannie Mae was able to extract an $11.6 billion mortgage-repurchase settlement from Bank of America (BAC) this year — its largest to date — because the bank needed Fannie's approval to sell billions of dollars in servicing rights.

That's the conclusion of a report set to be issued Thursday by the inspector general of the Federal Housing Finance Agency, Fannie Mae's conservator.

Fannie used its leverage in approving mortgage-servicing transfers to resolve a bitter dispute with B of A. The dispute reached its nadir last year when B of A stopped selling some residential mortgages to Fannie because of their contentious fight over mortgage-repurchase claims.

Fannie claimed many of the soured mortgages it bought from 2000 to 2008 from B of A and Countrywide Financial (which B of A later acquired) were defective at the time they were sold. B of A had countered that another settlement — which the report did not name — superseded Fannie's claims and exempted the bank from further repurchases.

The stalemate was broken after more than a year of meetings — and substantial differences in opinions about the values of the loans in question — when the two sides eventually agreed that B of A would pay $3.6 billion for loan losses, repurchase roughly 30,000 loans for $6.7 billion and pay $1.3 billion in compensatory fees for not foreclosing on borrowers in a timely manner.

"Nonetheless, Fannie Mae was able to bring Bank of America to the negotiating table due to the bank's interest in completing a significant sale of [mortgage-servicing rights] to third-party servicers," the report says. "Specifically, Fannie Mae would not consent to Bank of America's proposed transfer of the mortgage-servicing rights until B of A agreed to a resolution of Fannie's claims for compensatory fees."

In January, B of A announced the sale of more than $300 billion in mortgage-servicing rights on 2 million loans at the same time it announced the Fannie settlement. Nonbank servicer Nationstar announced it had bought $215 billion of mortgage for $1.3 billion, and Walter Investment bought $93 billion of mortgages for $519 million.

Resolving mortgage and other crisis-era woes has been a major goal of Brian Moynihan, B of A's chief executive. When the settlement with Fannie was approved, Moynihan called it "a significant step in resolving our remaining legacy mortgage issues, further streamlining and simplifying the company and reducing expenses over time."

The report did not say how much Fannie lost on the B of A loans, but it made clear that the financial stakes were very high. The final settlement covered 2.9 million loans originated from 2000 to 2008 with an unpaid principal balance of $414 billion as of July 31, 2012. Before pay downs, liquidations and refinances, the original loan count had been 8.2 million with an unpaid principal balance of $1.38 trillion.

The purpose of the watchdog report was to evaluate how well the FHFA oversaw the settlement. The agency complied with its own policies in reviewing the mortgage repurchases, the report said, but it did not have an established process for reviewing other aspects of the settlement, notably the $1.3 billion in compensatory fees for deficiencies in managing foreclosures.

The OIG's review shed light on the government-sponsored enterprises' little-known practice of charging compensatory fees to servicers for delaying foreclosures. The compensatory fees themselves have never been disclosed, and banks have long considered them contradictory. On the one hand, the government has urged banks to slow down foreclosures to help troubled borrowers, yet the GSEs charge millions of dollars in fees for not foreclosing on defaulted borrowers in a timely manner.

B of A agreed agreed earlier this year to pay Fannie the $1.3 billion of compensatory fees. The fees amounted to $664 million as of September 2012, and the remainder includes claims for loans foreclosed on late last year, and projected claims for a large number of mortgages that were transferred in the sale of mortgage-servicing rights. Both parties agreed to a "true-up" process, so B of A may be required to pay more, Fannie may have to repay some money to B of A, or the initial payment could be unchanged, the watchdog report says. That process will be completed by Sept. 15.

The FHFA has agreed to the inspector general's recommendations that it establish guidelines for both compensatory fee claims in excess of $50 million and for significant transfers of mortgage servicing rights. Jeffrey Spohn, FHFA's deputy director of conservator operations, wrote in an Aug. 6 letter that FHFA will assess significant agreements to resolve outstanding compensatory fee claims. It plans by Jan. 31 to develop guidelines on documentation for, and management responsibilities in transfers of mortgage-servicing rights.

The watchdog report also mentioned that Freddie Mac had both a substantial compensatory fee claims against B of A and wished to transfer mortgage-servicing rights, but Freddie "did not wish to pursue a resolution along the same lines" as the one finalized with Fannie. There is no indication that FHFA "weighed the possible merits of Freddie Mac's divergent approach to the issue," the report says.