In a must read Op Ed, Bloomberg's Jon Weil takes another long hard look at the balance sheet of the most undercapitalized bank in America (thank would be Bank of America) courtesy of the worst M&A transaction in history, namely its purchase of Countrywide, observes what everyone, even John Paulson now knows, that due to trading at half its book value nobody in the market gives even remote credit to the bank's asset "marks", and concludes that this organization, courtesy of an extremely lax regulatory and audit structure, which continues to allow it to mark any assets at whatever price it desires, could well be the next AIG: "There’s more
at stake here, however, than whether Bank of America’s shares
are a “buy” or a “sell.” The main thing the rest of us care about is the continuing
menace this company and others like it pose to the financial
system, knowing we never should have let ourselves be put in the
position where a collapse in confidence at a single bank could
wreak havoc on the world’s economy. Here we are again, though.
Curse the geniuses who brought us this madness." Indeed: once again, right before our eyes, day after day we allow various higher status quo-embedded individuals to take advantage of the gullible public by misrepresenting the massive risk that the left side of BAC's balance sheet represents, which can have only one conclusion: the same epic implosion that brought down AIG once the market reality caught up the with book myth. Yet in the case of AIG unbridled risk-taking and book mismarking we can at least put the blame on one person: the man at the heart of AIG FP, Joe Cassano, whose reckless bets nearly brought down capitalism. So our question is: is there someone at or affiliated with Bank of America that could soon double as a Joe Cassano for the 2010s? We have one suggestion (although certainly not exhaustive): Brian Lin of RRMS Advisors.
Who is Brian Lin?
Let's step back and look at some of the recent developments regarding Bank of America. As most know by now, the biggest wildcard regarding Brian Moynahan's bank, and the biggest wildcard as pertains to the "known unknown" that is the bank's massive undercapitalization, is that it has hundreds of billions in legacy non-performing Countrywide loans. The same loans which the bank recently scrambled to settle with a group of litigants for the paltry sum of $8.5 billion. This is also the Rep and Warranty reserve that Bank of America took out this quarter after repeatedly promising that it was well over reserved for any future such litigation. Incidentally Zero Hedge has said repeatedly that this amount will be far higher when realistic assumptions are used, whether for modelling purposes, or when the full reality of the deterioration of the loan quality is uncovered.
Sure enough, in a filing today at the Supreme Court in New York, the Federal Home Loan Banks which are pursuing more information from the bank in an attempt to generate greater recoveries, have suggested that the the entity conducting the recovery assumptions that generated the $8.5 billion settlement was potentially incompetent (and arguably criminally negligent - our assumption not theirs), and that a "reasonable settlement" would nearly triple the amount of money that Bank of America would have to charge off: a range of $22 billion to $27.5 billion. Of course, should BAC do this, its Tier 1 Capital would plunge, it would immediately be forced to access the equity capital markets, and confidence in the bank's books would evaporate instantaneously, with all the nightmarish AIG-esque consequences envisioned by Jon Weil materializing immediately.
So who is the person largely responsible for the "overoptimistic" analyses that have so far spared Bank of America from a death spiral?
The abovementioned Eddie Lin of RRMS advisors.... And formerly of Bank of America!
Let's take a look at the FHLB's filing:
BNYM notes that it has now released on a website “all of the expert reports submitted to the Trustee in connection with the Settlement” and implies that those reports may provide all the additional information that the FHLBs need to decide whether to object to the proposed settlement. Unfortunately, however, the expert reports raise more questions than they answer. By way of example, BNYM published a report from Mr. Brian Lin of RRMS Advisors about the reasonableness of the $8.5 billion that BNYM agreed to accept as part of the proposed settlement. Mr. Lin concluded that “a settlement figure somewhere between $8.8 and $11 billion is reasonable.” But to reach that conclusion, Mr. Lin made certain assumptions, the bases for which are not fully disclosed in his report.
Mr. Lin started with the full remaining principal balance of the loans in the 530 trusts that would be covered by the proposed settlement, plus the amount that the trusts have lost on loans that have already been liquidated. Together, Mr. Lin calculates that to be $208.9 billion. Mr. Lin then assumed that (1) only a certain percentage of those loans would go into default and (2) even for those loans that went into default, the trusts would recover between 45% and 60% of the principal balance through foreclosure. Both of these assumptions are quite controversial, and the FHLBs need to understand Mr. Lin’s basis for them. Using those assumptions, Mr. Lin concludes that the potential shortfall to the trusts, and therefore the amount that the trusts could potentially recover from Countrywide and Bank of America, is reduced from $208.9 billion to $61.3 billion.
To get from $61.3 billion to a “reasonable” settlement range of $8.8 to $11 billion, Mr. Lin made two more assumptions. He assumed that only 36% of loans that go into default will have breached Countrywide’s representations and warranties about the quality of its underwriting. That assumption is difficult to understand. Mr. Lin did not do any independent analysis of this assumption. Instead, he simply adopted Bank of America’s estimates of this percentage, which in turn appear to have been based on a completely different portfolio of loans that were subject to the underwriting standards imposed by Fannie Mae and Freddie Mac. Moreover, Mr. Lin’s assumption is inconsistent with widely publicized reports by professional loan auditors that even Countrywide loans that are merely delinquent (that is, behind on payments but not yet in default) have a “breach rate” of well over 60% and often as high as 90%. Finally, Mr. Lin assumed that only 40% of loans that both go into default and have breached Countrywide’s representations and warranties could be successfully put back to Countrywide and Bank of America. This assumption similarly demands investigation. It is hard to imagine why a court would not require Countrywide and Bank of America to repurchase all loans, not just 40% of loans, that are both in default and have breached a representation or warranty.
Each of these assumptions has a great effect on Mr. Lin’s estimate of the amount of a reasonable settlement. As an example, even if just the last assumption were changed from Countrywide and Bank of America having to repurchase all, rather than just 40%, of loans that were both in default and breached Countrywide’s representations and warranties, then Mr. Lin’s estimate of a reasonable settlement would rise from a range of $8.8 to $11 billion to a range of $22 to $27.5 billion. Modifying any of his other three assumptions would cause that range to rise much more.
Similarly, BNYM also published a report by Prof. Robert Daines about Bank of America’s liability as a successor to Countrywide. But Prof. Daines’s report leaves unanswered several critical legal and factual questions. Indeed, Prof. Daines admits that his opinion is “limited by the available factual record and certain assumptions that I make,” and he concedes in several parts of his report that he relied on unverified information provided by Bank of America
A closer look at Mr. Lin's biography indicates that he may have just a little conflict of interest when conducting his analysis, which most likely ended up being used in the bank's own application of settlement calculations, and reciprocally used as well by the counterparties, which we are more than certain are doing all they can to merely shut the case, instead of actually seek equitable damages. After all, as a reminder the adversaries to BAC in the case are the who's who of comparable borderline illegal marking pratices: Maiden Lane III, LLC; Metropolitan Life Insurance Company; Trust Company of the West; Neuberger Berman; Pacific Investment Management Company LLC; Goldman Sachs Asset Management; Thrivent Financial; Landesbank BadenWuerttemberg; LBBW Asset Management plc, Dublin; ING Bank and so forth. To say that these parties are not comparably guilty of similar practices would be beyond naive.
Anyway, back to Mr. Lin, and specifically his LinkedIn Profile where we learn that before RRMS he worked at... Merrill Lynch, and not just anywhere, but in the bank's Non Agency Trading. To wit:
Surely while developing a skillset about evaluating security impairments at Bank of America, Mr. Lin also developed numerous relationships. One may only wonder to what extent these relationships were "utilized" in assisting him in forming his opinion on what the proposed trust shortfall, and thus settlement, and thus potential material undercapitalization of Bank of America, should be.
But why pick only on Brian: let's take a look at the pristine organization that is RRMS. For that we turn to Crain's New York where we read that...
At RRMS Advisors' offices in an aging building on East 40th Street, Vincent Spoto and his four partners share space with a small headhunting outfit, and they hold meetings in a windowless conference room the size of a large closet…
Mr. Spoto, who was laid off more than a year ago from his position as a mortgage specialist at Credit Suisse, is grateful that he has a job. He has reinvented himself as a consultant to investors who hold toxic mortgage investments…
“There's a stigma out there, no doubt, because I was part of Wall Street,” ...along with a dash of guilt—he is among the band of survivors of Wall Street's collapsed mortgage machine who are getting the chance to assist in sorting out the financial mess they helped create. In fact, some of them are in high demand because they are among the few who understand complex instruments such as mortgage-backed securities, collateralized debt obligations and other products whose imploded values can only be guessed at…
“These are the people who can fit the key in the lock,”…“The problem for a lot of these Wall Street guys is that they don't know much about real estate,” says Robert Baron, president of American Real Estate Executive Search Co. in Manhattan. “All they know is a lot about slicing and dicing mortgages and selling them.”…
Over his 20-year career, Mr. Spoto worked mostly with mortgage servicing companies to ensure they were collecting on the mountains of loans that investment bankers packaged into securities and sold…Brian Lin, a veteran mortgage trader who was formerly with Merrill Lynch and other companies…
The firm also has Robert Pardes, who was chief lending officer at New Jersey-based OceanFirst Financial Corp. until May 2007. He was ousted after the bank disclosed that employees were hiding losses in the subprime lending division, which it had acquired from Mr. Pardes seven years earlier”
The plot thickens: not only do we have a person who may have a conflict of interest courtesy of prior professional relationships with Bank of America Merrill Lynch, but the firm he currently works boasts such individuals who were terminated for knowingly misrepresenting and hiding losses in RMBS books.
Does one now see why perhaps Mr. Lin may not have been the best choice to evaluated the trust shortfall, and the "settlement" process. Perhaps somebody slightly more objective would figure out that instead of $8.5 billion, Bank of America is actually on the hook for an amount that is at least 3 times greater if one uses proper impaired security valuation protocols?
However, as noted above, the question becomes "what then?" Should the true extent of deterioration of Bank of America's books be revealed, then its market cap would be not $100 billion but some modest fraction thereof. In fact, even John Paulson, formerly the biggest believer in BAC has now washed his hands. And he doesn't give up (read: look foolish to the investment community) easily. Our advice is to have a chat with Jon Weil: after all he is the man who said to "Curse the geniuses who brought us this madness."
In the meantime, and in the absence of Mark to Market, we are confident that the legal process will prevail and that the presiding judge on this case, and if not him then certainly the New York District Attorney, will step up and demand a thorough reevaluation of the settlement process. Because if law itself is held hostage by a bank's massive undercapitalization, then one may as well admit that America has devolved into complete fascism.
As for our question if Mr. Lin is the second coming of Joe Cassano, the answer is likely no. It is everyone that behaves just like Lin, in allowing what is blatant disregard for fair and equitable process, to continue... in exchange for give or take 30 pieces of silver (physical, not paper).
Unfortunately in our rapidly devolving society we have gotten to a point where the next epic collapse will have not one but an army of Joe Cassano's behind it.
h/t Manal Mehta