Now I know why the Federal Housing Financing Agency (FHFA) took 3 years up until the statute deadline to file this suit…they got nothing.
FHFA is alleging “material misrepresentations” in Registration Statements by BAC
- The stated “owner occupancy” vs “investment” data was materially false
- Stated LTV was materially false
- Underwriting standards were not adhered to
We’ll break them down piece by piece…
FHFA is claiming that the owner status of the mortgages they bought was materially false in the prospectus. Because of that the agency says BAC is liable. It says:
110. A review of loan-level data was conducted in order to assess whether the statistical information provided in the Prospectus Supplements was true and accurate. For each Securitization, the sample consisted of 1,000 randomly selected loans per Supporting Loan Group, or all of the loans in the group if there were fewer than 1,000 loans in the Supporting Loan Group. The sample data confirms, on a statistically-significant basis, material misrepresentations of underwriting standards and of certain key characteristics of the mortgage loans across the Securitizations. The data review demonstrates that the data concerning owner occupancy and LTV ratios was materially false and misleading.
111. The data review has revealed that the owner occupancy statistics reported in the Prospectus Supplements were materially false and inflated. In fact, for the seventeen Securitizations whose Prospectus Supplement represented the Supporting Loan Groups to be overwhelmingly owner-occupied, far fewer underlying properties were occupied by their owners than disclosed in the Prospectus Supplement and more correspondingly were held as second homes or investment properties.
112. To determine whether a given borrower actually occupied the property as claimed, a number of tests were conducted, including, inter alia, whether, months after the loan closed, the borrower’s tax bill was being mailed to the property or to a different address; whether the borrower had claimed a tax exemption on the property; and whether the mailing address of the property was reflected in the borrower’s credit reports, tax records, or lien records.
Failing two or more of these tests is a strong indication that the borrower did not live at the mortgaged property and instead used it as a second home or an investment property, both of which make it much more likely that a borrower will not repay the loan.
But wait, who declares a loan to be “owner occupied”? It is the buyer (see FDIC regs.). When potential buyers take out an application for a loan, they declare “under penalty of law” that the information they provide is correct. THEY are the ones who disclose whether or not a property is to be owner occupied or an investment.
Now, of course the lender has a obligation to vet the claims of the buyer to a reasonable standard. But, if we are to adjudicate whether of not they did, this must be done on a “loan by loan” basis and the mortgagees now must also be brought in to determine if they committed fraud. Even if the mortgagee is brought in he or she can claim the situation changed at the time they took out the loan. He or she can use the “I intended to live in it but got a great offer to rent it out” argument…no fraud. The buyer could have moved in for 20 days, bought another “primary residence” and then rented this one. Thus the data submitted by BAC would have been erroneous after the fact but not at the time. PLUS, FHFA would have to prove deceptive intent on the part of the bank OR the mortgagee.
The above action is not applicable to settle this claim. It cannot be done in mass and has to be done case by case. Further, false representation here would have been by property buyers, not the banks.
Skeptics will say it was a “wink wink” by the lender and the buyer. OK, prove it loan by loan. It can’t be done this way.
Loan to value (LTV)
116. The data review has further revealed that the LTV ratios disclosed in the Prospectus Supplements were materially false and understated, as more specifically set out below. For each of the sampled loans, an industry standard automated valuation model (“AVM”) was used to calculate the value of the underlying property at the time the mortgage loan was originated. AVMs are routinely used in the industry as a way of valuing properties during prequalification, origination, portfolio review and servicing. AVMs rely upon similar data as appraisers—primarily county assessor records, tax rolls, and data on comparable properties. AVMs produce independent, statistically-derived valuation estimates by applying modeling techniques to this data.
117. Applying the AVM to the available data for the properties securing the sampled loans shows that the appraised value given to such properties was significantly higher than the actual value of such properties. The result of this overstatement of property values is a material
understatement of the LTV ratio. That is, if a property’s true value is significantly less than the value used in the loan underwriting, then the loan represents a significantly higher percentage of the property’s value. This, of course,121. These inaccuracies with respect to reported LTV ratios also indicate that the representations in the Registration Statements relating to appraisal practices were false, and that the appraisers themselves, in many instances, furnished appraisals that they understood were inaccurate and that they knew bore no reasonable relationship to the actual value of the underlying properties. Indeed, independent appraisers following proper practices, and providing genuine estimates as to valuation, would not systematically generate appraisals that deviate so significantly (and so consistently upward) from the true values of the appraised properties. This conclusion is further confirmed by the findings of the Financial Crisis Inquiry Commission (the
“FCIC”), which identified “inflated appraisals” as a pervasive problem during the period of the Securitizations, and determined through its investigation that appraisers were often pressured by mortgage originators, among others, to produce inflated results. See FCIC, Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (January 2011). increases the risk a borrower will not repay the loan as well as the risk of greater losses in the event of a default.
121. These inaccuracies with respect to reported LTV ratios also indicate that the representations in the Registration Statements relating to appraisal practices were false, and that the appraisers themselves, in many instances, furnished appraisals that they understood were inaccurate and that they knew bore no reasonable relationship to the actual value of the underlying properties. Indeed, independent appraisers following proper practices, and providing genuine estimates as to valuation, would not systematically generate appraisals that deviate so significantly (and so consistently upward) from the true values of the appraised properties. This conclusion is further confirmed by the findings of the Financial Crisis Inquiry Commission (the “FCIC”), which identified “inflated appraisals” as a pervasive problem during the period of the Securitizations, and determined through its investigation that appraisers were often pressured by mortgage originators, among others, to produce inflated results. See FCIC, Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (January 2011).
See argument for #1 above. BAC relied on the appraiser estimation of value for the LTV ratio. Using that data in the prospectus is reasonable. Now, if those “estimates” turn out to be wrong, there is no libel. If they turned out to be out and out fraudulent, then there is libel on the part of the appraiser. BUT, in order to prove that, we have to go on a case by case basis and now bring in the appraiser (assuming the appraiser is still in business and can even be found). Again, the above action is not the forum to determine this.
Now again, skeptics will say BAC should have know what was going on. I would retort that shouldn’t the FHFA also known and if it did not, they why should the former? This is the FHFA’s only business, the argument should be made that FHFA should have known it better than BAC and at the very least actually examine some of what they bought.
FHFA continually uses the “reasonable investor” standard which, oddly enough means the buyer is “market savvy.” BAC can easily claim that FHFA was negligent because it relied solely on the claims and representations of BAC and the ratings agencies to make purchase decisions. It did no DD of its own (none is claimed in the filing) into what it was buying so in that effect, it is contributory. Why? If it is true that the defects claimed in the securities were present when they were bought, had FHFA done ANY DD, they would have been discovered. The ONLY argument the agency was NOT contributory is that those defects were not there at the time of purchase in which case this suit is a waste of time. Odd predicament.
122. The Registration Statements contained material misstatements and omissions regarding compliance with underwriting guidelines. Indeed, the originators for the loans underlying the Securitizations systematically disregarded their respective underwriting guidelines in order to increase production and profits derived from their mortgage lending businesses. This is confirmed by the systematically misreported owner occupancy and LTV statistics, discussed above, and by (1) investigations into originators’ underwriting practices by government officials and private litigants, which have revealed widespread abandonment of originators’ reported underwriting guidelines during the relevant period; (2) the collapse of the Certificates’ credit ratings; and (3) the surge in delinquency and default in the mortgages in the Securitizations.
This is a “kitchen sink” argument. LTV and owner occupancy are addressed above. (1) investigations: The argument is “because there was poor underwriting there, it must be true for this also.” OK, but, that is not how it works. The prior argument was from Option One in MA (it did 100% of 6 originations claimed out of 22). The argument on BAC is essentially:
130. BOA also departed from its own underwriting standards as a consequence of striving to increase the volume of subprime mortgage loans it originated between 2004 and 2007. In 2004, Bank of America announced its commitment to invest $750 billion over 10 years in
48 low-and moderate-income (“LMI”) communities through consumer loans and other programs. FCIC Report at 97; see also BOA Press Release, “Bank of America Community Development Lending Exceeds $85 Billion,”
This gets us into the whole CRA discussion that required this behavior from banks (*CRA, Pub.L. 95-128, title VIII of the Housing and Community Development Act of 1977, 91 Stat. 1147, 12 U.S.C. § 2901 et seq).
But that is really neither here nor there. If BAC stated an intention to loan to these people through this program and the standards set for it were disclosed. Because it then made loans under this program does not mean the “did not adhere to their standards.” It means it changed some of them to accommodate this legislation.
We will address (2) and (3) together. This is the chicken and eggs argument that FHFA can’t win. BAC will argue that the surge in delinquency and defaults was due to the severity of the recession. Since the recession caused those, it only is a reasonable claim that the downgrades were then caused by it also. FHFA cannot argue that “housing caused the recession” because consumers also have far too much credit along with auto debt. We also then need to get into a business cycle argument (recession come every 7-10 years and the last one was in 2001) and what effect that had. Then we can also talk about the global slowdown etc. Unless the agency can prove “loan “A” led to this,” it can’t win the argument.
So, what is this about then? FHFA filed suit one business day before the statute of limitations ran out. Why? There isn’t really anything there. What they are doing is declaring a seat at the table for any possible settlement talks. What will happen? BAC's max exposure here is $6B. I will say that this is settled in part with a larger settlement that finally extinguishes these suits and any future ones. Maybe BAC settles this for $500M? A drop in the bucket when you consider the $36B it pulls in a year. It will settle because it is best for all involved to put it behind and move on and litigation will take years (at least 2-3).
I said it yesterday and it bears repeating. What we are seeing here is eerily reminiscent of 1998-99 and tobacco stocks. Remember? The litigation then was going to wipe them out also. It worked out VERY well for investors then and I am becoming more sure every day this will also.