Tuesday, August 16, 2011

Bank Of America's Backdoor Bailout - Dumping Mortgage Trash Onto Taxpayers Via Fannie Mae

Bank of America's back-door TARP

Taxpayer-owned Fannie Mae just bought the servicing rights to a bunch of bad loans from the struggling Bank of America. Where does it end?

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FORTUNE -- Taxpayers may not realize it, but they just bailed out Bank of America again, this time to the tune of more than a half billion dollars.

The Charlotte, NC-based bank was one of the biggest recipients of bailout funds during the financial crisis. But Bank of America (BAC) continues to face deep problems related to its troubled mortgage portfolio and investors have battered the stock, which has plunged over 40% so far this year. That's escalated concerns that the bank may need to raise more capital. Yves Smith at Naked Capitalism has even started a BofA death watch.

But apparently the federal government is determined to resurrect BofA: the Wall Street Journal reports the feds have just used Fannie Mae, which is controlled by the U.S. government, to infuse BofA with $500 million and ease one of the bank's biggest headaches.

Yesterday afternoon on CNBC, Bank of America CEO Brian Moynihan mentioned that five of BofA's six businesses were making money. The one black spot was its massive portfolio of problematic mortgages and the liabilities flowing from it. Moynihan also mentioned that BofA had just sold some "mortgage servicing rights" as part of its balance sheet strengthening efforts, but he didn't elaborate.

According to the WSJ, Fannie Mae spent $500 million to buy the servicing rights to a big chunk of the "seven million loans still causing the most problems." Although the $500 million is a paper loss to BofA, in that the rights were "originally worth more," it looks like BofA is still getting a good deal because the portfolio's "value is expected to deteriorate further."

In fact, the deal is worth much more than $500 million to BofA, because getting rid of those servicing rights lifts a huge cost burden off BofA's shoulders. And if securitized loans are involved, which they most likely are, the sale also limits the BofA's potential liability to investors for its current servicing violations. Finally, the $500 million is surely more than the servicing rights are worth in an arms-length transaction. How do we know? Beyond the comment that the loans are expected to "deteriorate further," the goal of the intervention can only be to fix Bank of America's capital structure, which is easier for the government to do if it overpays for the rights.

In short, purchasing these servicing rights was another Troubled Asset Relief Program.

Servicing defaulted loans can be good business if cheaply produced foreclosure paperwork isn't questioned, and if the foreclosures have equity and can be resold easily with lots of junk fees. But the mortgage servicing rights Fannie Mae bought are stinkers: they have a 13% delinquency rate, which means lots of foreclosures and loan modifications.

Both foreclosures and mods have been big headaches for BofA, which faces potential liability for document fraud in its foreclosures on multiple fronts. Beyond that, foreclosures are simply expensive to do well. BofA was recently punished by Treasury for failing to do modifications well, and it's also been sued for how it does them.

But the loans Fannie Mae now has to deal with are even worse than 13% delinquency rate suggests. According to the WSJ, "more than half of the loans are in troubled U.S. real-estate markets." This likely means markets where a high percentage of the houses are underwater and there's a huge oversupply, driving prices down further and making defaults more likely.

Fannie Mae is purchasing "the servicing rights in order to transfer the day-to-day management of those loans to a different company." That's another huge sign that Fannie Mae is overpaying. If the rights were really worth $500 million, wouldn't a private company pay that for them? Instead, it sounds like Fannie Mae is doing a bailout two-step, one to BofA and one to whomever takes these rights off Fannie Mae's hands.

Another thing needs to become clear: where did Fannie Mae get the money to do BofA the favor of buying these rights? Fannie Mae just asked for another bailout of its own, seeking a new $5.1 billion infusion last week.

Think about how good this deal is for BofA: it gets to stop the bleeding, or at least cauterize much of the wound in its balance sheet that lousy mortgage servicing rights and mortgage securities liabilities are creating. And it gets half a billion dollars to boot.

And taxpayers? Well, we get to own yet another good chunk of BofA's mess

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