Why is the "truth," meaning the objective truth, so hard to come by? I am astounded by all of the misinformation and, perhaps, disinformation -- the latter meaningfully pejorative -- about BAC's settlement with Fannie Mae and Freddie Mac.
First of all, lets lay it out: Bof A is paying $2.6 billion to government-sponsored entities in order to solve $18 billion in claims against mortgages gone bad that were issued by Countrywide Financial, leaving about $4 billion in claims still extant. The agreement covers current and future claims on 787,000 loans by loans sold by Countrywide through 2008 and 12,045 loans sold to Fannie Mae.
Again, the latter can still bring claims for future losses, but BofA claims it is reserved, presumably at some reasonable level based on the default rate of the loans, which, of course, is ridiculously high.
That's the story. Fifteen cents on the dollar. That's what they paid. Again, there are more claims to come, but that's the ratio that they are paying out on.
The articles this morning, all except the Financial Times, which really got this right, go on to say that BofA still faces a slew of mortgage putbacks and that they are going to be very expensive. We don't know exactly how much is at stake, but we know that the private-label claims are supposed to be roughly equal to the entire claims of the GSEs, which, again, are about $22 billion.
Because of that last figure and the prospective claims that can still be contested by Fannie Mae, we hear again that there is $30 billion in exposure -- BofA didn't even go down on this news! We are told, told by very reputable journalists, although not the FT, which, again, nailed this issue, that it is way too early to "celebrate," as if a move from $11.50 in October to $14 now, with a huge resolution, equals celebrating. A stock move like that is simply a catch-up to a player like C and is nowhere near the longer-term gains of WFC, which is still devouring Wachovia's issue.
Here's the problem with the $22 billion in private-label claims that we are supposed to be fearful of, claims by outfits like BLK and AZ and Pimco, as well as, bizarrely, the New York Fed. I say "bizarrely" because the Fed isn't a huge claimant here, and, frankly, it may not even have standing.
But let's think about these claims of these private entities vs. the government entities. These private entities are all sophisticated. They all bought these mortgages not because they were trying to help the system by boosting home ownership but because they were trying to reach for yield. They all had models which showed defaults. Sure, there were a lot of no-doc loans, but they knew that. Sure there were lots of possibilities that the loans were phony, but they built that into their models. Or they should have, because boy oh boy were there ever stories written about it.
Each of these firms had a model that predicted a certain percentage of defaults based on employment figures. In every single instance of home-price declines since the Depression, it was employment losses that triggered the declines. They all knew this!!
Almost every entity therefore reasoned that it was worth it to reach for yield while employment was strong, betting that the defaults would be historically low.
The fact that these institutions are sophisticated and motivated by profit -- not by the charter to promote home ownership -- is a huge hurdle for them to overcome. Huge. Why is this not a part of the story? These firms borrowed at low rates and then bought these pieces of paper as an arbitrage to capture the interest differential. That's not the same as buying paper to get more people to buy homes, a government imperative.
Therefore, the case isn't that good as the government case, simply because you can bet that no court is going to be as sympathetic to profit-seeking sophisticated investors vs. government-sponsored entities that packaged loans to fulfill their government charters, even if the government entities were hopeful to make a profit.
Now, unlike the GSEs, these profit-seeking entities relied on purportedly diligent ratings agencies to make their decisions. The fact is that the agencies are a huge mitigating factor for Bank of America. Nobody told these companies to buy this stuff. No one put guns to their heads. They had ample resources to do due diligence, yet they mostly relied on the agencies for the work they did. I have to believe that, because if they had done their own work, they would have found what we were writing here, that the paper was universally suspect.
Therefore, it is very hard for me to believe that these profit-seeking entities would get -- not be owed, but get -- the same settlement from BofA as the GSEs, which BofA needs badly in order to continue its ongoing mortgage business, which represents 20% of the entire mortgage market. Put simply, BofA can't afford to alienate Fannie and Freddie.
It can easily afford to alienate the profit-seekers.
But it may not even have to. I am sure that the profit-seekers would love to get 15 cents on the dollar from BofA, given that that's all that it had to give to an entity that trusted Countrywide's assurances.
I can tell you, though, they ain't getting that. Bank of America, now run by a lawyer, Brian Moynihan, knows that he has many more cards with these profit-seekers than he had with the GSEs. The leverage of the GSEs was immense. They also had unlimited legal firepower.
That's not the case of the profit-seekers, and Moynihan knows that very well. They can't afford to litigate endlessly, but BofA can, because BofA knows that in the end, it has judges looking at what it paid Fannie and Freddie, which did not have the sophistication or the motive that these other buyers had.
Plus -- and this is really important and not mentioned in any of the stories -- these private entities could have taken either side. They didn't need to buy this paper as part of their charters. They could have easily kicked the tires, not relied on the agencies and reached the conclusion that they should be sellers, not buyers, of the paper, as so many firms were.
My conclusion: You can take that $22 billion and give it a haircut that will probably amount to no more than 10 cents per share. Or it could be nothing at all, owing to the sophistication of the plaintiffs.
Lets say 10 cents.
$2.2 billion.
Much of it reserved.
That's what I think is the true exposure.
The "celebrating" is over, because the market looks like it is going to roll over. To me, the story is clear: Do not fear the liability. It's vastly overblown.
I was far more concerned about the Fannie and Freddie exposure.
The bears will say, "But the agencies lay down for Bank of America." To which I say, give me a break. The public anger against BofA made it so that Fannie and Freddie hardly rolled over. It got what it could.
The profit-seekers should be so lucky.
long BAC
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