The US Federal Housing Finance Agency (FHFA) is to sue 18 underwriters of private-label mortgage-backed securities as part of its attempts to recoup some of the multi-billion losses that Fannie Mae and Freddie Mac suffered from their mortgage-backed securities exposure.
The agency (which is the conservator of the two government-sponsored enterprises) filed one suit against UBS on July 10, following it up with a second suit on September 2 naming 17 further banks, including Bank of America Merrill Lynch, JPMorgan Chase, Royal Bank of Scotland, Goldman Sachs and others.
Limitations
The market is braced for a surge in MBS fraud-related cases as time is running out for claimants to act. The FHFA claims that the banks misrepresented the underlying mortgage loans and gave investors false information about their quality. In September 2008, Congress passed a measure placing a three-year statute of limitations on such claims. The FHFA claims have a limit of two years from the discovery of facts or five years from the illegal activity. The SEC itself has a five-year limit for assessing penalties.
UBS might have been the first bank targeted by the FHFA in July for strategic reasons. It has hardly been a poster child for bad practices and was only a mid-tier player. "The banks are pushing hard against a sampling method of assessing violations and are insisting that loan-level violation must be demonstrated," explains Evan Thomas, an analyst for Capstone, a Washington DC-based financial advisory firm specializing in policy analysis. With a 10th of the market share of Bank of America, UBS is a more manageable initial target for evidence collection.
The banks might argue that the GSEs were among the most sophisticated MBS investors in the market but are unlikely to get very far.
"It does not matter how big or sophisticated a security purchaser is, the seller has a legal responsibility to accurately represent the characteristics of the loans backing the securities being sold," states the FHFA. The expectation is that the banks will take a big hit. "Given the GSEs only purchased triple-A rated tranches and the correct characteristics would not have warranted that rating, we believe the GSEs have a strong argument," says Chris Gamaitoni, vice-president and mortgage finance research analyst for Compass Point Research and Trading.
The FHFA has rebutted recent press reports claiming that it will seek around $200 billion in damages. "These numbers reflected the original amount of securities purchased, not the losses incurred or the potential recoveries at the end of the process," it said in a September 6 statement.
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| Compass Point’s estimate of FHFA’s redress |
Gamaitoni estimates that the agency will be seeking redress for losses of just over $36 billion. However, he expects that several banks will settle out of court. "We view a decision not to settle as a risky strategy," he warns. The FHFA is in negotiations with several banks not named in the suit, one of which is understood to be Wells Fargo. According to the Compass Point estimates, Fannie and Freddie incurred $35 billion of losses on $198 billion of securities purchased from the 17 banks named in the second suit. This includes $11 billion on purchases from BAML and $6.2 billion from JPMorgan. The FHFA is estimated to be seeking $962 million from UBS on purchases of $4.5 billion. The UBS suit is the only suit that asks for specified damages (of "at least" $900 million).