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Wall Street Whispers: Bank Stocks' Real Risk

With the private RMBS market still largely frozen, bond insurers have been paying out claims and hanging onto litigation, without writing any new business. A judge has allowed a lawsuit by MBIA (MBI), begun in the fall of 2008, to move forward, but it hasn't moved past the discovery stage. The trial isn't expected to begin until July.

THE REAL RISK

It's unsurprising that, as the party with the deepest pockets, big banks are taking the brunt of legal claims from the mortgage mess.

But in assessing the real litigation risk, it's worth putting one's self in the shoes of judges who will ultimately decide which parties are left bearing the cost of souring mortgage debt. Would you find in favor of homeowners who are broke and delinquent? What about monoline insurers whose business model is clearly busted? Or investors who bought lousy product in a frenzy and are now performing more comprehensive due diligence, years after the deals were done?

Ultimately, the government seems to be the only party involved in the mortgage reckoning that poses a significant risk. As taxpayer-funded institutions working to repair the housing market, the GSEs are sympathetic. And since their buyback processes are well-established, they had effectively been "settling" before anything had to go to court, with banks repurchasing tens of billions of dollars' worth of souring debt.

While overall reserves are dropping across the industry, repurchase reserves have been the only area where banks added billions in capital last quarter. Still, Adams says the GSE buyback demands haven't been excessive so far.

"Fannie and Freddie don't really want the banks to be blown up by these mortgage putbacks," he says. "They want to do it in a way that allocates some risk back but keeps them in business and keeps them sending loans their way."

Things have started to become a little less amicable, though.

Shortly after the GSEs' regulator, the Federal Housing Finance Agency, began talking tough about banks' refusal to repurchase certain loans, the Federal Home Loan Bank of Chicago, which is also a GSE, filed suit against Citigroup (C). Additionally, the Federal Deposit Insurance Corp. is examining the practices of banks who entered "loss-share" agreements to acquire failed bank assets. If those banks are found to have engaged in "robosigning" or any other unsavory practice related to acquired mortgages, those incentives will be shelved or clawed back.

And while Bank of America has called claims by Pimco, Blackrock and the Federal Reserve Bank of New York "utterly baseless," the Fed's mere appearance on a formal buyback request letter was troubling.

"I know from your standpoint the fact that they signed a letter was a surprise to you," Bank of America CEO Brian Moynihan said at a conference on Nov. 4. "It surprised me and I think it surprised a lot of people, quite frankly."

Still, Moynihan didn't seem overly concerned. He characterized the issue as a process that comes with the territory of running a large, diverse financial institution. He noted that BofA has sued companies over mortgage issues as well. He has also spoken with Larry Fink, the head of BlackRock, in which Bank of America was a major investor at the time the letter was sent.

"I called Larry," said Moynihan, saying his counterpart responded, "'Yes, we'll work through it.'"

-- Written by Lauren Tara LaCapra in New York.



>To contact the writer of this article, click here: Lauren Tara LaCapra.

>To follow the writer on Twitter, go to http://twitter.com/laurenlacapra.

>To submit a news tip, send an email to: tips@thestreet.com.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.
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