How bad are the potential damages?
Let me start out by saying that estimating B of A’s liability for Countrywide’s securities fraud is an inexact science at best. Making it worse is the fact that B of A has been tight-lipped about these actions in particular.
Roughly two years ago, the SEC sent a letter “reminding” banks that they must disclose exposure “relating to various representations and warranties that you made in connection with your securitization activities and whole loan sales” — by “representations and warranties” it’s referring to the breach-of-contract cases. But it notably didn’t require banks to disclose exposure to securities fraud claims, and they similarly aren’t obligated to publish litigation reserves, which could be used to back into estimates. Consequently, as Reuters’ Alison Frankel has pointed out, “Damages have been an open question in the MBS securities litigation.”
Given the uncertainty, the range of potential damages in these cases is extremely broad. In an analogous case brought by the Federal Housing Finance Agency against UBS AG (USA) (NYSE:UBS), the overseer of Fannie Mae and Freddie Mac claims that the government-sponsored agencies “lost in excess of 20%” of their investment in $4.5 billion worth of the Swiss bank’s MBSes. If you apply this multiple to the $716 billion of mortgages packaged into MBSes by Countrywide, you arrive at an astounding $143 billion in potential liability — a patently absurd figure that’s far more than enough to bring B of A down. Of course, the claim against UBS is also just that, a claim. If it settles with the FHFA, the settlement amount would likely be a fraction of the purported losses.
Fortunately, a number of settlements in other cases moderate this considerably. In July of 2011, Wells Fargo & Company (NYSE:WFC) paid a group of investors $125 million to settle securities fraud actions related to $35 billion in MBSes. Four months later, Citigroup Inc. (NYSE:C) and Deutsche Bank AG (USA) (NYSE:DB) paid the National Credit Union Agency a combined $165.5 million to settle claims related to an estimated $30 billion in MBSes sold to five now-defunct credit unions. Using these multiples, B of A’s potential exposure reduces to a much more reasonable range of $2.6 billion to $3.9 billion.
So what is it, $2.6 billion or $143 billion? The answer is that It’ll likely fall somewhere in between these figures, though I believe much closer to the former than the latter. One reason for this is that B of A has a number of viable defenses. In addition to the statute of limitations, which has already knocked multiple claims out of court, there’s “reliance” — that is, did these sophisticated institutional investors really rely on Countrywide’s statements in the offering documents? If it can be shown they didn’t, B of A will be off the hook for at least the state and common law portions of the securities fraud cases. And if they did rely on the documents, then there were disclaimers in the offering documents — with typical rear-end covering for the issuer — that would have presumably been relied upon as well. Finally, B of A can argue that the true source of the damages suffered by MBS investors was the financial crisis and not false representations made by Countrywide.
On the other hand, there are a number of factors that work in the MBS investors’ favor. For one, if the facts asserted by the plaintiffs in all of these lawsuits are true, then the underlying fraud at Countrywide was both rampant and provable. This matters because it could sway judges and/or juries. Additionally, the mortgages originated by Countrywide between 2004 and 2008 were among the worst, if not the worst, in the industry.
A wide range of potential damages
Given the comparatively early stages of the securities fraud litigation and the lack of precedent, any estimate of potential damages here must necessarily include a wide margin of error. With this in mind, my estimate (and that’s all it is, an estimate) is that B of A will end up paying between $5 billion and $15 billion to resolve these claims.
The article The Biggest Unknown Threat to Bank of America originally appeared on Fool.com and is written by John Maxfield.
John Maxfield owns shares of Bank of America. The Motley Fool recommends American International Group (NYSE:AIG) and Wells Fargo. The Motley Fool owns shares of American International Group, Bank of America, Citigroup, and Wells Fargo and (NYSE:WFC) has the following options: Long Jan 2014 $25 Calls on American International Group.
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