If Bank of America Corp.'s proposal to settle its mortgage-backed securities claims for $8.5 billion is approved as is by a court, the deal would provide the template for other banks to clean up their own MBS messes.
That is certainly still an if, as a judge would have to make the settlement binding on an unknown portion of investors who did not participate in the negotiations. But it has a good shot, because it serves several powerful interests.
The pact would provide a way for Bank of America to close out most of its private-label exposure it inherited from Countrywide, help Bank of New York Mellon Corp. avoid an increasingly complicated legal morass, and repay investors with at least a small portion of their losses on mortgage-backed securities.
It also helps drive a deeper wedge between activist mortgage investors and a larger group widely viewed as reluctant to push for an all-out fight with major banks.
The deal relies on an unusual role for Bank of New York Mellon, the trustee for 530 Countrywide mortgage-backed securities trusts with an original face value of more than $424 billion. As a trustee, the bank has generally held that it would not take action without either a direct default or a concerted investor action that would protect it from either liability or costs. But in the case of the B of A settlement, BNY Mellon has accepted an indemnification from B of A itself and will push to force all of the trusts it oversees to enter into the deal. Though the trust banks have repeatedly emphasized that they are not obligated to take independent action on such matters, BNY Mellon in this case decided that it wished to.
Trust law experts contacted by American Banker said that Bank of New York Mellon was likely on solid, if novel, ground.
Since only a minority of investors have even tried to pursue B of A over losses on the securities, many are likely to view the $8.5 billion payment as a good deal even if it amounts to only pennies on the dollar of total losses. Likewise, the settlement is a victory for the 22 major investors that signed on with Gibbs & Bruns — participants like BlackRock Inc. and the Federal Reserve Bank of New York wanted to recoup part of their losses but were unlikely to demand a resolution that would involve great harm to the nation's largest bank. "We have been systematically looking at risk and … where we have parties that will work with us to try to reduce those risks on terms that are fair to our shareholders," B of A CEO Brian Moynihan said on his company's morning call.
Less sanguine are likely to be activist investors who sought to organize their peers behind a massive effort to put back loans and extract concessions for servicing failures. Such pushes may suffer if a sufficient portion of participants can be lured into accepting the settlement.
"We've known it's coming, we've known it's a sweetheart deal, and now we've got actual proof," said Bill Frey, CEO of the hedge fund Greenwich Financial Services LLC. The 22 entities that have backed the settlement did not invite other investors to join them for negotiations, he said. "I would hope that the unions that have handed money to BlackRock and PIMCO object to an obvious sweetheart deal," he said.
Representatives of other Countrywide mortgage litigants either did not return calls or said they were still wading through the settlement proposal.
BNY Mellon declined to speak publicly about the deal, though in its proposed settlement it said that it believed the $8.5 billion was more money than investors could ever recover on their own, in part because Bank of America could choose not to backstop Countrywide's obligations if large judgments were obtained. In light of the complexity of the litigation — and the growing number of demands investors have made upon BNY Mellon itself — the bank argued that a global solution was both desirable and necessary. "It benefits far more trust beneficiaries now — given the substantial settlement payment and the nature of the servicing improvements — than could litigation involving separate trusts and separate groups of certificateholders over the course of several years," BNY Mellon wrote.
Still, there are hurdles. In court, activist investors could demand to opt out of the settlement or challenge whether the trustee was acting in their best interest given that it has been indemnified by Bank of America. There's also the prospect of convincing the judge reviewing the settlement that it should simply be for a larger sum.
A research note from Compass Point analyst Chris Gamaitoni made the point that the $8.5 billion settlement, while nominally large and in keeping with Bank of America's estimates, was significantly below what many analysts had expected private-label investors would eventually be able to recoup through litigation.
"We believe this proposed settlement is just a starting point and will likely increase meaningfully after the court hears arguments from other invested parties," he wrote, pointing to the $106 billion in defaulted loans that the securitizations in question have already produced.
Moreover, Gamaitoni noted, analysts have yet to be wrong in forecasting larger mortgage put-back losses than Bank of America has predicted.
"From the [Fannie and Freddie] side to the private label side, management has guided low and had to increase everytime there's been a material event it's been meaningfully higher," he told American Banker.