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Lenders like Bank of America Corp and Wells Fargo & Co say they are facing mounting pressure to buy back bad mortgages they sold to investors, signaling that banks' home-loan headaches could continue for years.
Investors like Fannie Mae and Freddie Mac have been pressing banks to buy back bad mortgages for years, but in recent months those requests have intensified, the banks have said in recent second-quarter earnings reports.
These comments from banks provide a fresh reminder of the loose ends that remain from the housing bust that started five years ago. The threat of new expenses and litigation is dampening bank share prices, and the problem could linger for some time, analysts and experts said.
"This is not done yet," said Paul Miller, analyst with FBR Capital Markets. "There will be continued surprises in the industry."
The most pain will likely be felt by Bank of America, which said on Wednesday its total outstanding claims from investors surged more than 40 percent to about $22 billion US in the second quarter. The bank's shares fell nearly 5 percent as investors worried about future losses and dropped again on Thursday.
At a time of low interest rates, U.S. banks are making many new loans to borrowers buying homes and refinancing, but anxiety about the costs of old loans is overshadowing some of this success.
During the housing boom in the last decade, banks parceled billions of dollars of loans into highly-structured residential mortgage-backed securities they then sold off to investors. The buyers of these loans included the now-government controlled agencies Fannie Mae and Freddie Mac, as well as private investors.
When selling the mortgages, banks made promises or "representations and warranties" about the loans. Investors can ask banks to buy back soured mortgages if these promises were evidently broken, for reasons such as poor underwriting, insufficient verification of income or other documentation errors.
Banks have fought some of these claims, but most lenders still expect to have to buy back many of the mortgages.
Bank of America, the second-largest U.S. bank, faces the biggest threat from repurchase requests because in 2008 it bought subprime lender Countrywide Financial, a major producer of toxic loans during the housing boom. Its mortgage unit has posted more than $30 billion of losses since the beginning of 2010.
About half of the bank's claims are from Fannie Mae and Freddie Mac, which were placed in government conservatorship in 2008 as their loan losses ballooned.
Tensions are so high between Bank of America and Fannie Mae that the bank stopped selling some loans to the agency in February. According to a securities filing, Bank of America had the most outstanding repurchase requests with Fannie as of March 31 - $7.1 billion, or 58 percent of outstanding claims.
The bank, in its earnings presentation, said Fannie Mae's repurchase standards have been changing and differ from the bank's interpretation of its contracts. The bank, for example, has noted an increase in claims on loans in which the borrowers have made payments for at least two years.
Bank of America argues that when borrowers have made payments for two years or more, it is hard to fault the bank's underwriting instead of, for example, the state of the economy.
Fannie Mae and Freddie Mac said they are looking out for U.S. taxpayers in making their claims. Fannie, for example, has said it may need more funds from the U.S. Treasury if it collects less than expected from Bank of America.
"Under our contracts, lenders are required to repurchase loans that are delivered to Fannie Mae but do not meet our standards," Fannie spokesman Andrew Wilson said. "We pursue repurchases in order to minimize losses and protect the interest of taxpayers."
Freddie Mac doesn't think taxpayers should have to pay for ineligible loans sold to the agency, said spokesman Michael Cosgrove. The top three reasons for Freddie's claims against banks are problems with borrowers' income, loans that don't meet the bank's automated underwriting standards and problems with collateral or appraisals, he said. Freddie does not disclose claims by each bank.
ADDING TO RESERVES
Banks, including Wells Fargo and PNC Financial Services Group Inc said they expect to have to pay investors more than they previously thought, and they set aside additional funds to cover the requests. Fifth Third Bancorp on Thursday said it expects claims to increase later this year.
Wells Fargo, the biggest U.S. mortgage lender, set aside $669 million to cover repurchases, up from $242 million a year ago, when it posted second quarter earnings last week.
"We want to make sure that we have got that reserve absolutely accrued for appropriately," Wells Chief Financial Officer Tim Sloan said in a conference call with analysts. "We saw the agencies continuing to adjust their requests."
PNC added $438 million to its reserves, up from $21 million a year ago.
Bucking the trend was JPMorgan Chase & Co, which said claims had reached an "inflection point" and were declining.
In addition to a jump in requests from Fannie Mae and Freddie Mac, Bank of America said it is getting more claims from private investors who want to meet statute of limitations requirements. These claimants weren't part of an $8.5 billion settlement the bank reached last year with major institutional investors.
For the second quarter, Bank of America added $395 million to its repurchase reserves, which was more than the first quarter but way down from the $14 billion it set aside a year ago to cover the $8.5 billion settlement and other repurchase requests.
The bank now has about $16 billion in reserves to cover these claims, but FBR Capital Markets analyst Paul Miller wrote in a research note on Wednesday that the bank may not be putting enough aside to cover its future losses. Bank officials later called him to argue that they have sufficient reserves, he said.
The bank gave him a very strong argument, but he hasn't changed his mind, Miller said. "I have my opinion. They have their opinion," he said.
Bank spokesman Jerry Dubrowksi said the bank's calculations take into account the fact that collateral backs about half of its $22 billion in outstanding claims. In addition, the bank has historically paid out 8 to 12 cents on the dollar for the remaining balance for settlements with private investors, he said.
The bank on Wednesday said it is not possible to "reasonably" estimate the possible losses to Freddie Mac and Fannie. It did not change its estimate that losses to private investors could cost $5 billion more than existing reserves.
"We have significant reserves to handle potential representations and warranties claims," Dubrowski said.
Industrywide, repurchase requests may be near their peak, but are likely to remain a concern for at least another year or two, said Cliff Rossi, a teaching fellow at the University of Maryland's business school and a former bank executive.
"We are certainly not through it," he said. "It's another thing to give uncertainty to investors."