When we last looked at the Bank of America joke of a "non-settlement" settlement for a paltry $8.5 billion when $424 billion in total misrepresented (530 in total) Countrywide mortgage trusts were at stake, we said, "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." We were, oddly enough, correct. According to a just released filing from the New York Attorney General Eric Schneiderman, Bank of America (and Bank of New York Mellon, one of the tri-party repo banks mind you), violated New York state law and "misled investors." In a knock out punch to Bank of America (and Brian Lin who was profiled here previously), the bank allegedly violated the New York’s Martin Act and misled investors about its conduct tied to mortgage securitization as Bloomberg summarizes. Schneiderman said he has "potential claims" against Bank of America Corp. and its Countrywide Financial unit. As Zero Hedge alleged all along, "The proposed cash payment is far less than the massive losses investors have faced and will continue to face." What does that mean? Well, as the countersuit by the FHLB indicated (which we are certain will be the basis for the NY AG claims), the likely final settlement is probably going to be about $22 to $27.5 billion. Which also means that the bank's Tier 1 capital is about to be discounted by about 25% lower. Which, lastly, means that the stock is about to plunge due to a massive litigation reserve shortfall which will have to be plugged with, surprise, a new equity capital raise. Which brings us to our original question: got CDS (which closed around 200 bps today, roughly 25 bps wider - it is going much wider tomorrow, especially if the expected Sarkozy-Merkel-Zapatero meeting achieves absolutely nothing)? Cause this baby is going down... and it is probably about to be broken up into good BAC and bad bank, consisting almost entirely of all legacy Countrywide operations. Said otherwise, it could well be time for a CFC-BAC CDS pair trade.
From the suit:
The Attorney General of the State of New York Eric T. Schneiderman (the “Attorney General”) has statutory and common law authority to safeguard the welfare of New York investors and the integrity of the securities marketplace generally.
Pursuant to this authority, the Attorney General seeks to intervene in this proceeding to protect the marketplace and the interests of New York investors, the vast majority of whom otherwise are not present before the Court in this proceeding.
Moreover, the Attorney General has an interest in this proceeding because the proposed settlement may interfere with his ability to pursue claims against BNYM, Countrywide, BoA, or affiliated entities.
The Attorney General therefore seeks an order pursuant to CPLR 401, 1012, and 1013 granting him permission to intervene as an adverse party in this proceeding to protect the interests of the People of the State of New York.”
Some more from Bloomberg with another quick summary of the facts:
“The allegations by the New York Attorney General are outrageous, baseless, unsupported by fact and law and we will fight them if necessary in court,” Ron Gruendl, a BNY Mellon spokesman, said in an e-mail.
“We are confident that we have fulfilled in all respects our responsibilities as trustee,” Gruendl said. “The AG’s action is misguided and fails to comprehend the role of the trustee and the benefit the settlement would provide to investors.”
Bank of America and Countrywide separately face liability for “persistent illegality” in breaching contractual promises about the quality of loans, as well as failing to provide complete mortgage files, Schneiderman said in court papers.
Lawrence Grayson, a spokesman for Bank of America, declined to comment.
And for those who are completely unfamiliar with the situation here is the big picture gist from a recap by HuffPost:
New York Attorney General Eric Schneiderman asked a state judge to reject a proposed $8.5 billion settlement agreement over soured loans between Bank of America and a group of investors, claiming in court documents that a separate bank representing the investors committed fraud for failing to ensure that the mortgage securities were created in accordance with state law and for failing to act in the investors' best interest. Bank of New York Mellon, the trustee representing the investors, "knowingly, repeatedly, and consistently" misled investors into thinking that the mortgage bonds were created properly, Schneiderman said in court documents. BNY Mellon also put its own interests before those of the investors it's supposed to represent, he said.
BNY Mellon, the 11th-largest U.S. bank by assets and one of the nation's largest trustees, stands accused of "repeated fraud and illegality," according to court filings, which alleges that the abuses "were repeated literally hundreds of times."
In short, Countrywide Financial, the lender purchased by BofA in 2008, failed to properly assemble loan documents needed for the creation of mortgage securities, and BNY Mellon effectively looked the other way, which "apparently triggered widespread fraud," Schneiderman said in court documents. BNY Mellon should have known the mortgage securities were improperly created because the evidence was "abundant," Schneiderman asserted, citing the bank's own documents, news coverage of "foreclosure fraud" and foreclosure actions brought on the bank's behalf.
It also opens up new worries for BofA, the nation's largest handler of home loans, as the company could be faced with the prospect of having New York's top legal officer determining that untold billions of dollars' worth of mortgages turned into securities by Countrywide, the nation's largest mortgage company when purchased by Bank of America during the credit crisis, aren't really securities at all due to failures in the security-creating process.
In court documents, Schneiderman is demanding that his agency be allowed to further examine loan documents to ensure the securities were properly created. New York's top law enforcement officer is using the Martin Act, a powerful state law that gives prosecutors broad powers to investigate fraud.
Long story short: Bank of America is now totally skewered (as in can you spell U-N-D-E-R-R-E-S-E-R-V-E-D), as this process throws the entire existing settlement, which most certainly was cobbled together with the assistance of the purported legal adversaries so that the American financial system was not scuttled when BAC has to file for bankruptcy, out of the window.
Now that a politically upstart AG is in the pic, and now that he has raised some serious rucus, we expect, as noted above, that the final settlement ask will increase by about $15-20 billion, and in the process sent the company's CDS soaring as the fear of counterparty risk suddenly rears its ugly head in a self-fulfilling prophecy along the same lines as took down Lehman Brothers.
Prepare for a Bank of America public offering. And for our Paulson & Co. LP readers: pray that the billionaire sold his remaining shares in this toxic dump of a bank on which he once upon a time had a $30 price target.
h/t Manal Mehta