BofA Settles Loan Repurchase Line - Analyst Blog - Bank of America (NYSE:BAC), Federal Home Loan (OTC:FMCC)

On Monday, Bank of America Corporation (BAC) agreed to pay $2.62 billion to Freddie Mac (FMCC) and Federal National Mortgage Association or Fannie Mae (FNMA). This will resolve the repurchase or “put back” claims related to certain residential mortgage loans sold to these Government Sponsored Entities (GSEs) by Countrywide Financial Corporation. Countrywide was acquired by BofA for approximately $4 billion in 2008.

BofA had been facing significant problems in its balance sheet since its acquisition of Countrywide. Though the settlement of residential mortgage loans sold by Countrywide will help the company improve its financials in the long run, higher provisions will mar the near-term results.

According to BofA's declaration, the settlement deal includes:

The payment of $1.28 billion to Freddie Mac for settling 787,000 loans claims (current and future) sold by Countrywide through 2008.
The payment of $1.34 billion (after applying credits to an agreed upon settlement amount of $1.52 billion) to Fannie Mae to resolve repurchase claims on 12,045 Countrywide loans (with approximately $2.7 billion of unpaid principal balance) and resolve other specific claims on 5,760 Countrywide loans (nearly $1.3 billion of unpaid principal balance).

However, BofA commented that the agreement excludes loans contained in private label securitizations, loan servicing obligations and other contractual obligations. In addition, the settlement claim deal does not cover $600 million buyback demand from Freddie Mac and loans covered by the deal that turn out to be fraudulent or violated fair lending laws.

BofA also stated that it will make a provision of $3 billion in the fourth quarter of 2010, including the amount to be paid to two GSEs and an additional $2 billion for potential compensation claims in future. The reserves for such claims totaled nearly $4.4 billion as of September 30, 2010.

During the third quarter 2010 earnings release, BofA had stated that it had received approximately $8.7 billion repurchase claims on $910 billion in mortgage-backed securities (MBS) sold to these two GSEs during the housing boom.

The put back problem started from the housing boom when the lenders (banks), who originated loans, sold them to Freddie Mac and Fannie Mae or to private investors as MBS. However, when the housing bubble burst, a large number of these loans and MBS turned bad. And recently, Freddie Mac, Fannie Mae and other investors are asking banks to repurchase these loans at the original value.

BofA is not the only bank exposed to such repurchase claims. Many other large banks and financial institutions are being forced to repurchase troubled home loans. On December 27, 2010, Ally Financial had entered into a deal with Federal National Mortgage Association to pay $462 million to settle put back claims over the mortgages sold by its subsidiary, General Motors Acceptance Corporation (GMAC) Mortgage LCC. Similarly, in November 2010, JPMorgan Chase & Co. (JPM) had announced that it is setting aside $1 billion to repurchase toxic loans originated by Washington Mutual.

Though BofA is poised to benefit from its large scale operations, prudent capital management and non-core asset shedding, concerns related to inconsistent credit quality and the negative impact of the new financial reform law and the CARD Act continue to linger.

We expect BofA's provisions to settle future repurchase claims to weigh on its fourth quarter 2010 results, which is expected to be announced on January 21, 2011.

Currently, BofA's shares maintain a Zacks #3 Rank, which translates into a short-term Hold rating. Also considering the company's fundamentals, we have a long-term Neutral recommendation on the stock.