Bank of America Reps And Warranties Reserve Surges Five-Fold As Claims Rise Steadily

Three months ago, in light of the then released news that various parties among which the New York Fed and PIMCO are seeking to putback $47 billion worth of mortgages to Bank of America, we looked at the bank's reserve for reps and warranties and came to the conclusion that it was woefully underreserved (see: Can You Spell U-N-D-E-R-R-E-S-E-R-V-E-D? If Not, Here Is A Visualization Aid). Today, to our complete lack of surprise, we find that the Bank's reserve for such demands has exploded nearly five fold to a number that is probably the highest in history, at $4,140 million compared to a tiny $872 million in Q3, primarily driven by the settlement by Fannie and its sell out General Counsel Tim Maoypoulos. This is also the main reason for the bank's huge "charge" today which caused Earnings to be well below expectations. That said, that particular settlement is just the beginning of the firm's putback woes. Of course, what the bank is doing here is pretending this is a one time charge and hoping investors will give it credit for the Q3 number being the trendline, as opposed to the Q4, when it is precisely the reverse. Furthermore, we predict that soon enough declining reserves in all other categories will soon be reversed much higher as the sad reality of the US consumer, who has already extracted all benefits from not paying a mortgage, will become very evident and bank charge off ratios will be the first to suffer.

Here is Brian Moynihan's explanation for this dramatic deterioration:

  • 4Q10 representations and warranties provision of $4.1B increased as the current quarter included $3.0B in provision relating primarily to the impact of previously announced agreements with GSEs
  • $8.0B of claims were resolved during the quarter, including $4.9B as part of the GSE agreements, leading to an overall $2.3B  reduction in claims
    • Monoline claims outstanding continue to grow as the monolines continue to submit claims and are generally unwilling to withdraw claims despite evidence refuting the claims
    • $1.9B in claims were received during the quarter from whole loan and private label securitization investors substantially related to 2005 through 2007 origination vintages
  • Increase in rescissions and approvals in 4Q10 was substantially impacted by the previously announced agreements with the GSEs

And since the bank is fully aware that investors will be scrutinizing its now allegedly criminal (see Allstate case) loan origination practices, it has provided the following breakdown:

Non-GSE Experience –2004-2008 Originations

From 2004 through 2008, $963B of loans were sold into private label securitizations or through whole loan sales

Origination Issuer

  • 74% originated through Countrywide
  • 10% originated through legacy BAC
  • 7% originated through legacy Merrill Lynch
  • 9% originated through other legacy firms

Originations by Product

  • 31% were prime originations
  • 18% were Alt-A originations
  • 16% were pay option prime originations
  • 26% were subprime originations
  • 9% were second lien originations
  • Repurchase claims activity through December 31, 2010:
    • $13.7B of repurchase claims received on 2004-2008 vintages
      • $5.6B in claims from monolineinsurers
      • $5.7B in claims from whole loan buyers
      • $1.7B in demands from private label securitization investors who do not have the contractual right to demand repurchase of loans directly
      • $800M in claims from one counterparty submitted prior to 2008
    • $6.0B of resolved repurchase claims on 2004-2008 vintages
      • $800M resolved with monolines; 15% were rescinded or paid in full (mostly second lien)
      • $5.2B resolved with private investors; 59% were rescinded
    • $7.7B repurchase claims remain outstanding on the 2004-2008 vintages
      • $4.1B have been reviewed and declined for repurchase
      • $1.7B in demands from private label securitization investors who do not have the contractual right to demand repurchase of loans directly
    • Repurchase losses of $1.7B
      • $630M related to monolines
      • $1.1B with private investors
  • Experience to date reflects:
    • 22.4% of loans sold have defaulted or are severely delinquent
  • 58% ($126B) of defaulted or severely delinquent loans made at least 25 payments prior to default or delinquency
    • Only a portion of these defaulted or severely delinquent loans will be the subject of a repurchase demand and only a portion of those would ultimately be repurchased
  • Significant differences between GSE and private label representations and warranties deal terms (slide 21)
  • Although non-GSE claims experience remains limited, we expect additional activity in this area going forward
    • It is possible that additional losses may occur
    • Various scenarios were evaluated as part of our planning process
    • A preliminary estimate of possible upper range of loss could be up to $7B to $10B over existing accruals
      • It does not represent a probable loss
      • It is based on current assumptions and is necessarily subject to change
      • A significant portion of this possible range of loss relates to loans originated through Countrywide prior to our acquisition
    • Counterparties and their claims still have significant legal and procedural hurdles to overcome
    • We expect resolution of these matters to be a protracted process, could take years to conclude
    • If valid claims are presented in accordance with contractual rights, loan repurchase claims will be processed appropriately
    • Where no such valid basis for a repurchase claim exists, we will vigorously contest any requests for repurchase

And tangentially, and confirming that banks are only that just in name, the firm's sales and trading revenues plunged sequentially from $4.5 billion to $2.6 billion and validated our observations that in Q4 trading virtually stopped. Q1, unfortunately, is so far not any different.

Full Q4 report


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