The Charlotte-based bank ignored its own underwriting standards when it originated the so-called “jumbo” loans, mortgages typically used for higher-end homes, the Justice Department contends. The bank represented the loans as prime even though employees and internal performance reports had raised concerns about their quality, the Justice Department said.
“Bank of America’s reckless and fraudulent origination and securitization practices in the lead-up to the financial crisis caused significant losses to investors,” Anne Tompkins, U.S. attorney for the Western District of North Carolina, said in a press release. “Now, Bank of America will have to face the consequences of its actions.”
Tompkins, who is based in Charlotte, added, “Our investigation into Bank of America’s mortgage and securitization practices continues.”
According to the Justice Department, five investors, including Wachovia Bank, bought roughly $850 million worth of the securities from Bank of America in early 2008. Federal officials claim that, as of June, at least 23 percent of the 1,191 securitized mortgages had defaulted or were delinquent.
Investors’ losses so far total $70 million, the Justice Department said. An additional $50 million in losses is expected, the department said, citing an estimate from Fitch Ratings.
The Justice Department and SEC have not specified how much in penalties Bank of America would pay if it is found guilty.
The cases are the first brought by federal authorities in connection with prime mortgages rather than the subprime loans that have been the subject of other litigation in the aftermath of the downturn.
Originated by Bank of America
The case centers on mortgages originated by Bank of America, unlike other litigation in which investors have claimed losses stemming from securities backed by Countrywide Financial Corp. home loans. Bank of America bought Countrywide in 2008. In a separate case, pending in New York, the bank and 22 institutional investors are seeking approval of an $8.5 billion settlement to resolve claims stemming from Countrywide loans.
Responding to Tuesday’s lawsuits, Bank of America said the investors knew what they were getting into when they bought the securities.
“These were prime mortgages sold to sophisticated investors who had ample access to the underlying data, and we will demonstrate that,” bank spokesman Lawrence Grayson said. “The loans in this pool performed better than loans with similar characteristics originated and securitized at the same time by other financial institutions.
“We are not responsible for the housing market collapse that caused mortgage loans to default at unprecedented rates and these securities to lose value as a result.”
The Justice Department, in its lawsuit, argues that the proportion of mortgages that defaulted or became delinquent is “abnormally high” for a pool of prime mortgages and “cannot be explained solely by the downturn in the real estate market over the last few years.” Federal officials said Bank of America sold them as “prime securitization appropriate for the most conservative” mortgage-backed securities investors.
Bank of America originated the loans in 2007 and sold them as securities in 2008, federal officials said. Each of the loans sold as securities had an initial principal balance of around $420,000, with some as high as $1.6 million, according to court documents.
According to government officials, the cases mark the first federal lawsuit brought by the federal government’s Residential Mortgage Backed Securities Working Group. President Barack Obama created the state-federal task force last year to investigate illegal activity – stemming from residential mortgage-backed securities – that contributed to the financial crisis.
Red flags
Federal officials say Bank of America employees had raised red flags to bank officials about the questionable quality of the loans.
According to the Justice Department’s lawsuit, a Bank of America trader expressed concerns in 2007 about the quality of the loans proposed for the securitization. The bank then decided to postpone the sale of the securities until January 2008, but that month the bank “again made efforts to put poor quality mortgages,” worth $24 million, into the pool, the lawsuit says.
The SEC’s lawsuit says a Bank of America bond trader in late 2007 began receiving an increase in complaints from his customers experiencing unexpectedly early cases of default in residential mortgage-backed securities sold by the bank.
The nation’s second-largest lender by assets also misled investors by telling them that bank officials were receiving documentation that verified borrowers’ income, when in many cases they were not, according to federal officials.
The SEC, in its lawsuit, says Bank of America violated federal securities laws by failing to disclose how many of the mortgages were originated through outside brokers not affiliated with the bank.
According to the SEC, about 70 percent of the mortgages fell into that category.
Bank of America, the SEC says in its lawsuit, knew that loans originated by outside brokers – in the bank’s wholesale channel – were “significantly more likely than loans originated by (Bank of America) employees to be subject to material underwriting errors, become severely delinquent, fail early in the life of the loan or prepay,” all of which hurt investors in residential mortgage-backed securities.
Bank of America exited the business of making loans through independent brokers in 2010.
‘A target on its back’
The latest two lawsuits create more legal headaches for Bank of America, which has been dogged by litigation in the wake of the housing downturn.
“Bank of America, ever since acquiring Countrywide and the mortgage market meltdown, has had a target on its back,” said Guy Cecala, publisher of Inside Mortgage Finance, an industry publication based in Bethesda, Md.
He said loans made through independent brokers have come back to haunt lots of lenders.
“Brokers weren’t sufficiently supervised back then,” he said. “The problems hadn’t really surfaced yet and people were still doing business with them.”
Around the time of the Bank of America deal, banks were struggling to find buyers for loans packaged into securities, which could have pressured issuers to slip loans of lower quality into deals labeled as prime, he said.
“This certainly could be an indication that they are going to go after other big issuers of securities,” Cecala said. “A lot of Wall Street firms could fall into the same category.”
Only Bank of America and its subsidiaries, including Merrill Lynch, are named as defendants in the two lawsuits, not individuals who worked for the bank.
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