In Bank of America Corp.'s third-quarter earnings call, Chief Executive Brian Moynihan invoked a series of metaphors in addressing the alarm over the company's mortgage repurchase liabilities.
Pugnaciously, he vowed not to stand for claimants who bought Chevy Vegas insisting that they wanted 12-cylinder Mercedes-Benzes. Underwriting is conservative now, and the damage is "sealed in" from years of risky lending in the middle of the decade. "The issue is how long the flight will take," Moynihan said, the pig is passing through the snake.
So far, money set aside to cover buybacks of faulty mortgages appears to be a slender fraction of servicing portfolios, a proxy for originations and the pool from which repurchase demands emerge (see charts). But views on whether the industry has swallowed more than it can handle vary widely — from the contention that the largest banking companies face potentially devastating blows to loss estimates that would amount to manageable earnings drags in the coming years.
Typical analyses isolate stages through which a mortgage must pass before the final cost to lenders can be determined. Out of the trillions of dollars of mortgages issued in the most reckless years, say 2005 through 2008, so many will default; defects will be discovered in so many of those; lenders will successfully fend off a certain percentage of repurchase demands; and lenders will absorb a certain amount of losses on the balances they wind up buying back (assuming recoveries from sales of seized properties, for example).
Using such an approach, FBR Capital Markets has reckoned that the lifetime toll for the industry might be $44 billion, KBW Inc.'s Keefe, Bruyette & Woods Inc. put it at a potential $57 billion and Barclays Capital at $75 billion.
That range is not so bad compared to the more than $18 billion the six largest servicers — which account for about 80% of the total market according to National Mortgage News — have either realized as losses in the past five quarters or now have in reserve for repurchases.
But, in a report last month, Barclays emphasized the bewildering uncertainty over assumptions in different stages of the chain.
Repurchases emanating from Fannie Mae and Freddie Mac have been a routine part of the mortgage business for some time, and analysts and lenders believe that bill can be quantified with precision.
Relatively few losses, meanwhile, have been recognized in connection with assets sold to private investors, and the potential size of the final cost is a matter of guesswork.
Barclays said some factors "are almost like binary events." On the one hand, putbacks out of nonagency bonds face stiff hurdles like requirements that large numbers of investors act in concert even to begin reviewing loans, and agreements under which loan defects in themselves are not sufficient to compel a repurchase — unlike with Fannie and Freddie, defects may need to be shown to have actually triggered default. On the other hand, Barclays said, if actions like the lawsuits initiated by three Federal Home Loan banks and loan file subpoenas issued by regulators bear fruit, the "floodgates" are likely to open to a torrent of investor claims.
Assuming that about 40% of the roughly $3.5 trillion of nonagency mortgages originated from 2004 through 2008 default, that 30% of putback demands are successful, and lenders realize losses equal to 55% of the balances they repurchase, ultimate losses for the industry (excluding Fannie and Freddie loans) would jump from about $35 billion to about $140 billion if the percentage of defaults subject to repurchase demands jumps from 15% to 60%.
Still, analysts have taken comfort in Moynihan's fighting spirit, expecting that the struggle over repurchases will play out in legal standoffs over years, giving the industry room to earn its way past them.