Bank of America took a big hit when it reached a record-breaking $16.65 billion mortgage settlement with the United States Department of Justice in August. The company is likely to attempt to recoup as much of the penalty as it can by forcing correspondent lenders as well as local and regional banks to repurchase loans originated in the run-up to the housing crisis that allegedly violated underwriting standards. The good news for these companies is that the settlement arms them with a fresh line of defense.
The deal with the DOJ resolved federal and state claims related to how Bank of America and Countrywide Financial, which it purchased in 2008, packaged and sold residential mortgage-backed securities and collateralized debt obligations in the years preceding the financial crisis. It also resolved allegations about problems with the bank's mortgage underwriting and origination practices.
As part of the settlement, Bank of America released a "statement of facts" that includes a number of striking admissions. Bank of America acknowledges that it sold billions of dollars' worth of RMBS without disclosing to investors key facts about the quality of loans backing them, allegedly costing investors billions of dollars in losses when the securities collapsed. The bank also concedes that it originated risky mortgage loans and made misrepresentations about the quality of those loans to Fannie Mae, Freddie Mac and the Federal Housing Administration.
The statement of facts is a treasure trove for correspondent lenders and smaller banks facing buyback demands because it includes numerous facts that contradict or undercut Bank of America's current claims against those defendants. For example, the statement describes how Countrywide repeatedly represented to investors that it originated loans based on underwriting standards that were designed to ensure that borrowers could repay their loans, even though Countrywide had information that certain borrowers had a high probability of defaulting on their loans.
It also establishes that Countrywide concealed from RMBS investors its use of "shadow guidelines" that permitted loans to riskier borrowers than Countrywide's underwriting guidelines would otherwise permit. The company was more than willing to originate "exception loans" (i.e., loans that fell outside of its underwriting guidelines) so long as the loans, and the attendant risk, could be sold.
Countrywide acknowledges as part of this settlement that its prioritization of loan "saleability" led it to expand its loan offerings to include, for example, "Extreme Alt-A" loans. These loans, which one Countrywide executive described as a "hazardous product," essentially permitted borrowers to receive loans even if their self-reported income or assets raised substantial doubts about the borrowers' truthfulness. But Countrywide failed to tell investors that these loans were being originated outside of its underwriting guidelines. Countrywide concedes that it knew that these exception loans were performing far worse than loans originated without exceptions, although it never disclosed this fact to investors.
Based on these and other acknowledgements, it can legitimately be argued that Countrywide's underwriting guidelines in seller guides were essentially window dressing that obscured the fact that there really were no standards. Countrywide wanted to originate any loan that it could possibly sell.
As an attorney with a practice largely dedicated to assisting correspondent lenders as well as regional banks, I have defended companies throughout the country against a tremendous number of mortgage buyback and indemnification demands in recent years. We have demonstrated that the loans my clients originated were generally of very high quality. We have also long argued that a "reality check" was badly needed regarding arguments by major banks that they never would have bought loans from correspondents if the banks had any inkling that there might be a borrower misrepresentation or possible underwriting concern. Now the disingenuousness of those arguments is clear.
Bank of America's settlement comes on the heels of somewhat similar deals between the DOJ and JPMorgan Chase and Citigroup. Though perhaps not quite as far-reaching in their admissions, those institutions, too, have provided residential correspondent lenders and local and regional banks facing buyback or indemnification claims with plenty of additional fodder for counter-arguments. In short, these defendants now have extremely helpful additional resources at their disposal.
Philip R. Stein is a partner at Bilzin Sumberg, focusing his practice on complex commercial litigation.