Banks Can Live with $25B Deal — If It Gets Approved

WASHINGTON — The release of the last few details of the $25 billion mortgage servicing settlement this week revealed a deal that was, overall, not quite as bad for the banks as many observers and analysts expected.

But several obstacles remain, including getting a judge to approve the agreement. Among other problems are requests by a trade group that the court cap modifications of loans owned by investors, and fears that the failure of banks to admit any guilt or wrongdoing may hurt the settlement's chances of approval.

"Between calls from mortgage bondholders to protect their investments, from politicians who will see this settlement as allowing for pension groups to have to pay for the wrongdoings of these servicers, and some of the more ideological stalwarts who believe that wrongdoing must be established and admitted, I think there are still some major hurdles," Isaac Boltansky, a research analyst with Compass Point Research and Trading LLC.

There were few surprises in the hundreds of pages filed in federal court Monday. Much of the detail was revealed on Feb. 9, when federal officials and attorneys general from 49 states announced they had struck a $25 billion deal with Bank of America, Wells Fargo , JPMorgan Chase, Citigroup and Ally Financial.

In addition to imposing new servicing standards, the deal includes $10 billion for principal reductions; $3 billion to help underwater borrowers refinance into cheaper loans; $7 billion for other forms of relief such as payment forbearance for unemployed borrowers; and $5 billion in cash payments to individual states and the federal government.

The banks did not, however, admit any wrongdoing or guilt, which some observers said could open the settlement up to criticism from the court. Last year, Judge Jed Rakoff issued a scathing rejection of a proposed $235 million settlement between the Securities and Exchange Commission and Citi in which the bank was allowed to neither admit nor deny guilt.

"I thought the administration would pick that up as a mode of behavior going forward, but instead here you have it again," said Cornelius Hurley, director of the Morin Center for Banking and Financial Law at Boston University. "Twenty-five billion dollars purportedly, of neither admitting nor denying any reason why they're paying it. It defies logic."

But sources considered the Rakoff decision an anomaly, and said most people involved in the process were confident the court would approve the settlement, with or without the admission.

"You frequently see settlements where there isn't an admission of guilt, and you almost certainly have to expect that there wouldn't be admissions here," said Bob Davis, an executive vice president of the American Bankers Association, "because in certain designated areas, there is still open season for additional litigation."

Observers were eager to see what kind of credit the banks would receive for certain relief activities, how the banks would be required to modify loans, and in particular, how first liens and second liens would be treated under the settlement.

Brian Gardner, a senior vice president with Keefe, Bruyette & Woods, said those details appear to be beneficial for banks, as the banks would not have to write down all of the second lien in order to write down loans that have been securitized. "It does seem to me that banks are not forced under the settlement to write down loans on their books — be it first or second lien — before they turn to a securitized loan," Gardner said. "So I would see that as a slight positive for the banks."

Boltansky agreed that the structure of the monetary component, which lays out the credit banks will receive, was better for the banks than expected. "It gives them a little bit of optionality, especially when you start talking about those second liens, where they're going to get paid 10 cents on the dollar even for things that are 180 days past due, which generally you won't see anywhere."

Gardner said banks would be wise to tread lightly. While the formula does allow servicers to write down first-lien mortgages that have been securitized, he said the settlement also specifically preserves claims that could be brought by mortgage-backed bondholders.

The formula could be creating a whole separate cause of action, Gardner said. "It definitely doesn't force [banks] into a particular action, but if they take a particular action — going after a first-lien mortgage that's been securitized — then it's possible that you could see some action by bondholders," he said. "We'll have to wait and see."

The banks and state and federal officials are already getting pushback from mortgage bondholder trade groups.

The Association of Mortgage Investors, which represents investors of state and local pension and retirement funds, said Monday that it will ask a judge to amend the settlement to place a monetary cap on modifications of investor-owned loans.

"It is unfair to settle claims against the robo-signers with other people's funds," the statement said. "While we request that it not be done, at a minimum we request that a meaningful cap be placed on the dollar amount of the settlement satisfied by innocent parties. Again, restitution should come from those who are settling these claims, and lien priority must be respected."

Banks will get more credit for writing down second liens on its books than loans held by others, Laurence Platt, a partner with K&L Gates, wrote in a note to clients Monday.

For example, the servicer gets a $1.00 credit if it makes a payment to an unrelated second-lien holder for release of a second lien, but gets only a 20-cent credit if the forgiveness is given by the investor.

The amount of credit banks will receive for writing down second liens depends on the payment status of the loans. Servicers will get credit for writing down second liens only when the writedown facilitates a first-lien modification for a borrower 30 days delinquent or at imminent risk of default, or involves an occupied property with a second lien that is at least 30 days delinquent or at risk of imminent default, Platt said.

The settlement does not require a minimum amount of relief for second-lien loans, but at least 60% of the consumer relief provided by banks must be in the form of permanent principal forgiveness on qualifying first- and second-lien loans.

The administration has rebutted claims that the deal would be paid on the backs of teachers, firefighters and unions.

The Department of Housing and Urban Development issued a fact sheet Monday emphasizing that investors will not be forced to incur losses, and that servicers will not be able to write down securitized loans unless contracts with investors specifically allow it. The agency also emphasized that second liens will be written down according to the Hamp second-lien program, and that second liens more than 180 days delinquent will be extinguished.

Boltansky said the 180-day trigger, which was not part of the original Hamp initiative, could lead to more first-lien writedowns.

"If these institutions are now all agreeing to certain triggers to write down these second liens, not to mention are getting incentivized 10 to 90 cents on the dollar for it, it increases the likelihood that they are going to participate, which would in turn allow for more first-lien modifications," he said.