Insurers Sue Banks for Mortgage Losses

Ever wish mortgage lenders could get a dose of the same bitter medicine they doled out to homeowners? Well, your dreams may soon be reality.

Bond insurers, who guaranteed loan payments for mortgage-backed asset pools of home equity lines and loans, are seeking billions of dollars from Bank of America because of loans made by Countrywide, which BofA purchased in 2007. Other targets for lawsuits filed by MBIA include GMAC, Residential Funding Corp. and the FDIC, because of loans made by now defunct IndyMac Bank.

The claims by the insurers allege that the loans included in the mortgage-backed securities did not meet stated underwriting guidelines; therefore the loans included in the securities should be replaced, or the insurer should be reimbursed for losses.

Kevin Brown, a representative for MBIA, indicated that the bond insurer already paid more than $4.2 billion in losses on securities for which they gave guarantees. These guarantees were sought by the bond issuers to "provide credit enhancement," so the bonds would be rated higher and could be sold for more.

Each securitization includes pools of mortgages between approximately 8,000 and 48,000 mortgage loans. The bond insurer guarantees the monthly payments and must pay any shortfall to those investors that hold the security.

While Bank of America tried to have the case against it dismissed, an April 29 ruling allowed MBIA's lawsuit to proceed. It alleges fraud and breach of implied covenant of good faith and fair dealing. Bank of America also tried to get itself removed from liability, but the court denied the motion.

Will America's leading mortgage originator get pinned to the mat for fraudulent loans?
It certainly seems more likely than ever before. The issues in this case are similar to the investor lawsuit that was settled last week:

Countrywide Financial Corp agreed to pay $600 million and KPMG LLP agreed to pay $24 million to settle a shareholder class-action suit. The suit alleged misstatements and omissions regarding lending practices and procedures at Countrywide. In settling the lawsuit, Countrywide denied the allegations and said it did give investors full information during regular investor forums, and in SEC filings when it sold the securities.

But MBIA's Kevin Brown insists that MBIA was not given full information about the quality of the securities MBIA insured.

In the lawsuit MBIA Insurance Corporation v. Countrywide Home Loans, which does include Bank of America, MBIA asserts "Countrywide falsely represented to both MBIA and the investors that Countrywide had originated the Mortgage Loans in strict compliance with its underwriting standards and guidelines." Yet they claim Countrywide "developed a systematic pattern and practice of abandoning its own guidelines for loans origination and underwriting by knowingly lending to borrowers who could not afford to repay the loans, who committed fraud in loan applications" or who "did not satisfy the basic risk criteria for prudent and responsible lending."

MBIA used a forensic re-underwriter to review the loans within certain securities and found that 89 to 99 percent of loans in the securities were non-compliant, based on underwriting standards.

The key question not answered is: How many loans were in the sample reviewed by the forensic re-underwriter? Brown did not want to respond because the case is still to be heard, and specific evidence will be held until trial.

There are 15 different Countrywide securities questioned in this lawsuit. The case currently is set to be heard in early 2011.
Some examples of the problems that Brown said they found included: home-buyers granted loans even though their FICO scores were below underwriting standards; and buyers given high-dollar loans even though, based on their type of employment, they could never earn enough to pay off the loan.

Bank of America also indicated in its annual report that similar suits have been filed by Syncora Guarantee and Financial Guaranty Insurance Co. In addition to the insurer suit other investor suits related to Countrywide lending also were discussed in the annual report.

The insurers did not respond to inquiries about these lawsuits. Bank of America also did not respond at the time of this writing.

Lita Epstein has written more than 25 books including "Reading Financial Reports for Dummies" and "Trading for Dummies."
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