Analysis: In the U.S. housing market, recovery or Lost Decade?

(Reuters) - The worst U.S. housing crisis since the Great Depression has been declared over. But is it?

What some of Wall Street's forecasts for a recovery may be underestimating are tectonic shifts in the U.S. economy that make the housing market a different place from a decade ago.

Record levels of student debt, 15 years of flat incomes and the fact that nearly half of homeowners are effectively stranded in their houses look likely to weigh on prices into the indefinite future.

Several housing experts have said the market is in danger of drifting for years. In a bleaker scenario, the fragile U.S. economic recovery could slip back into recession if Europe's crisis deepens or the political impasse in Washington triggers a new budget crisis, putting the housing market at risk again.

"We've gone through half of a lost decade since the crisis started in 2007," said Robert Shiller, co-founder of the Case-Shiller U.S. housing price index and an economics professor at Yale University.

The so-called Lost Decade in Japan occurred after the speculative bubble in the 1980s, when abnormally low interest rates fueled soaring property values. The ensuing crash has continued to afflict the Japanese economy ever since.

"It seems to me that a plausible forecast is, given our inability to do stimulus now, for Japan-like slow growth for the next five years in the economy. Therefore, if there is an increase in home prices, it's modest," said Shiller.

A Reuters poll published on Friday showed most economists think the U.S. housing market has now bottomed and prices should rise nearly 2 percent in 2013 after a flat 2012.

GENERATION STAGNATION

Consider the plight of college graduates, who go on to become the biggest group of first-time U.S. home buyers.

Many graduate into a climate of falling wages and soaring rents, members of the most indebted generation in history who owe an average $25,000 in student loans.

They elbow their way into a labor market so rough that the number of people with jobs is at a 30-year low, health and retirement benefits are shrinking and the young workers face a greater chance of losing their jobs than any generation before.

For Steve Blitz, chief economist at ITG Investment Research in New York, the housing market improvement has gotten as good as it can without more improvement in the labor market.

"I don't see it worsening unless the economy goes back into a recession, but I think it's more a case of stagnating," Blitz said.

It is not just the employment picture that makes the prospect of a housing recovery so precarious.

Housing prices and income usually move in lock step. But real median household income is stuck at the same level as during the Clinton Administration in 1996 -- at about $49,000.

That means the housing market will remain troubled for "an extended period of time," according to Sam Khater, a senior economist at housing data company CoreLogic.

"It's not about job growth. It's about income growth," says Khater.

Back in 1996, the median home price was around $80,000. When house prices soared to $200,000 in 2006 -- the market peak -- it was due to jumbo mortgages, not jumbo pay raises.

Banks lured consumers with low interest rates that later turned much more expensive and blew up monthly payments, eventually helping to cause the housing crash.

On the one hand, the housing implosion has created a bonanza for those buyers who can take advantage of it: U.S. real estate is now 36 percent cheaper than in 2006.

In nearly every city, it now costs less to own than to rent.

But many would-be homeowners cannot buy. Lenders have virtually locked them out of the market by denying them mortgages, according to statistics from the Federal Housing Administration and a recent Morgan Stanley research report.

In May, consumers able to close on a mortgage had, on average, a near-perfect credit score. They could afford a 19 percent down payment on their new home. And they were still on track to spend no more 24 percent of their income on their new house, according to the Ellie Mae Origination Insight Report.

"Most of the population can't meet current mortgage underwriting standards," says trade publication Inside Mortgage Finance founder Guy Cecala. "They're getting eliminated before they even get to the door."

Some believe this credit freeze is only going to worsen. Washington is considering new mortgage regulations that would shift more responsibility for bad loans away from taxpayers and investors and toward banks.

"If all these new rules that Washington is talking about are put into place, it would be even harder to get a mortgage," said Brian Lindy, an analyst at Amherst Securities Group, which released a report in May entitled "The Coming Crisis in Credit Availability."

Even for those who can afford to, buying a house can be a harrowing experience. After watching a nation crash and burn, plenty of people remain in shock. They are loath to take the risk anytime soon.

As research firm S&P Capital IQ's Robert Kaiser said at a recent housing conference: "Consumer confidence simply hasn't recovered enough to support the housing market."

BUSTED CONVEYOR BELT

The housing market, as economists often like to point out, is a conveyor belt. A homeowner sells a house. The new buyer moves in, and the seller buys a better house. In time, that buyer in turn sells, and buys a better house.

Normally these so-called move-up buyers are the housing market's biggest consumer group. They are what keep that conveyor belt moving.

Today the apparatus is broken.

That's because about half of homeowners with mortgages simply can't move.

Twenty-four percent owe more on their houses than they are worth. Another 25 percent are equity poor, meaning they have less than the 20 percent of equity required for a down payment to trade up to a new home, according to housing-data company CoreLogic.

Sean O'Toole, the CEO of foreclosure-data aggregator ForeclosureRadar.com, estimates that it will take at least another decade, at the housing market's current pace of growth, for homeowners who are underwater just to break even on their houses.

"We went from $4.5 trillion of mortgage debt in 2000 to $10.5 trillion of debt in 2008 -- and we are still only down to $9.8 trillion," says O'Toole.

"All those people with negative equity, they can't sell. They are stuck in a prison of debt."

A HIT WITH MULTI-GENERATIONAL HOMES

The U.S. housing market is actually hundreds if not thousands of markets.

Cities such as New York and San Francisco have joined other world cities, like London and Hong Kong, to form a global housing market that aligns its fortunes with the wealthy elite.

Then there's Stockton, the California city that filed for bankruptcy in June. A recent Rockefeller Institute of Government research report suggested it could turn into a ghost town with its lack of jobs and abundance of abandoned, foreclosed homes.

Still, there's no doubt that in most places the housing market appears to have bottomed out and is now gathering strength.

The places that were hit hardest -- like the warm states where baby boomers go to retire -- are snapping back, and some states with strong income and job growth, like the natural gas haven of North Dakota, are solid.

"I don't think it's a head-fake, because when you look across all your price measures and construction measures on the starts side, you're seeing broad-based indication of improvement," says Beata Caranci, deputy chief economist at TD Bank Group in Toronto.

But even those who say the recovery is on are subdued. "We have to be a little bit cautious," said Caranci. "It's the beginning of a recovery."

The Case-Shiller home price index, considered a bellwether of the U.S. housing markets, rose in May for the third consecutive month.

Those price hikes, however, reversed just a sliver of the wealth lost since the housing peak: $200 billion of the $6.7 trillion that has evaporated since 2006, according to a recent Bank of America report.

Some of the biggest jumps -- such as the 10 percent year-over-year price gains in foreclosure-filled cities like Phoenix and Miami -- were largely due to banks holding back inventory. That's because of lingering legal problems from the so-called robo-signing foreclosure scandal as well as a reluctance to flood the market, according to CoreLogic's Khater.

"Don't let the volatility in prices fool you," he said. "Yes, prices are increasing in some markets, but in the longer term it has to come back to incomes, and unless incomes are increasing, price increases are not sustainable."

At this point in a typical cycle, executives at the homebuilding companies are usually the loudest members of the housing recovery pep squad. Yet the mood has been subdued in the most recent round of earnings conference calls with homebuilder executives.

In late June, Lennar, the third-largest homebuilder in the United States, reported a rise in new orders for the fifth straight quarter, helping to push share price to a year high in July.

Executives had foreseen that, after the housing crash, family members would start to live together as a way to save. Lennar started designing a new home that included a 600-square-foot apartment with its own entrance called the "Multi Gen Home." It has been a hit.

Nonetheless, Lennar's chief executive officer, Stuart A. Miller, told analysts in June that he was nervous about uttering the word recovery.

"I don't think that there's reason for exuberance right now -- except for the fact that the beatings have stopped."

(Additional reporting by Cezary Podkul and Tim Reid; Editing by William Schomberg, Mary Milliken and Prudence Crowther)

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Analysis: Banks largely reserved for U.S. mortgage pact cost (Reuters)

(Reuters) – As the nation's five largest mortgage lenders edge close to a $25 billion settlement over foreclosure abuses, it's becoming clear that the deal will have little or no impact on their future bottom lines.

After more than a year of negotiations, the banks already have set aside money to cover legal costs and have built up their reserves to cover losses from reducing how much borrowers owe. Accounting for these costs in past earnings means future earnings won't be affected much.

"If they're not fully reserved, I've got to believe the industry is pretty close," said Nancy Bush, a longtime banking analyst and contributing editor at SNL Financial.

State attorneys general and federal officials have been working on a settlement since allegations that banks improperly handled foreclosure paperwork emerged in the fall of 2010. More than 40 states have signed onto the agreement as of a Monday deadline, but key states, including California and New York, are still holding out.

The core banks involved in the talks are the largest mortgage servicers -- Bank of America Corp, JPMorgan Chase & Co, Wells Fargo & Co, Citigroup Inc and Ally Financial Inc. The U.S. Justice Department has also started to reach out to smaller regional banks about their inclusion in the agreement.

Under the proposed pact, the banks would provide $17 billion in loan modifications for delinquent borrowers; $3 billion in refinancing for homeowners who are current but unable to refinance because they owe more than their homes are worth; and around $1.5 billion in direct payments of up to $2,000 each to borrowers who lost their homes to foreclosure, according to a letter supporting the agreement sent Monday by Delaware banking commissioner Robert Glen.

In addition, participating states will receive a total of $2.5 billion for housing programs. The agreement also requires banks to reform their mortgage servicing practices under supervision of an outside monitor.

The lion's share of the settlement costs to banks would not be cash payments, but accounting entries to reflect the lower values of loans to be modified for borrowers. Many of those markdowns in value likely have been counted already as expenses when the banks added to loan-loss reserves, said Paul Miller, analyst at FBR Capital Markets.

"I don't see it as that big of a hit," Miller said.

BANKS TOOK CHARGES IN FOURTH QUARTER

A number of banks involved in the talks increased their legal reserves in the fourth quarter. These charges likely would cover the cost of payments to homeowners and for state foreclosure prevention programs.

Bank of America last month set aside $1.5 billion for litigation, partly for a possible settlement, while Ally Financial last week took a $270 million charge for penalties that it expects to pay.

JPMorgan's consumer segment booked $1.7 billion in costs in 2011 for mortgage litigation and foreclosure matters, partly for a settlement, the company reported on January 13.

"We should pay for the mistakes we made," JPMorgan Chief Executive Officer Jamie Dimon said in an investor conference call on January 13.

Citigroup said fourth-quarter expenses increased by 4 percent from the third quarter, or $476 million, due to higher legal and related costs driven partly by the mortgage business. Executives didn't comment specifically on the foreclosure settlement. Wells Fargo hasn't said how much it has booked for a possible agreement.

Among smaller banks, PNC Financial Services Group Inc and US Bancorp, reported a total of $370 million in mortgage-related expenses, and SunTrust Banks Inc said it may take a charge.

In addition to upping litigation reserves, banks also have been amassing reserves for losses on residential mortgages, even as they reduce reserves for other types of loans, such as credit cards. As of December, Bank of America, for example, had accrued $5.9 billion to cover residential mortgage losses, equal to 17.6 percent of its mortgage loans, up from $5.1 billion, or 12.1 percent, a year earlier. Setting the money aside hurt past earnings. But it will protect future earnings from bearing the cost of the proposed $25 billion settlement.

Under the settlement, banks will be required to reduce principal owed on some loans owned by the banks themselves. In certain cases they may also modify loans owned by other investors. Loans owned by government-controlled mortgage entities Fannie Mae and Freddie Mac are not covered by the pact.

The reserves set aside for the settlement are likely sequestered in multiple areas within the banks, said SNL's Bush. For example, banks will need to account for lost revenue from reduced interest and principal payments, she said.

"It's not very straight-forward," she said.

ACCOUNTING STANDARDS

Accounting professors Ed Ketz, of Penn State University, and Anthony Catanach, of Villanova University, said that stock analysts are probably right to expect that the banks have already taken out many of the costs when reporting quarterly profits and losses.

While the accounting rules leave a lot of room for judgment in recording expenses for contingencies, in this situation it is unlikely that the banks have dramatically understated the costs, the professors said. The likelihood that the banks would have to pay billions of dollars has been rising for a year in the sight of the public and regulators watching the financial press, the professors said.

"This one is too open to the public -- and there are enough other areas that the public is not aware of -- for them to try to play games with it," said Ketz. "They should at least have booked whatever minimum losses that they expect."

Accounting rules, the professors said, call for companies to apply two tests when deciding whether to go ahead and subtract costs for contingencies from earnings -- whether the expense is probable and, then, whether the amount can be reasonably estimated.

The banks may face criticism that they are getting off lightly in the settlement because they won't be announcing big new hits to profits, said Guy Cecala, publisher of industry publication Inside Mortgage Finance. The settlement also does only so much to compensate borrowers who have already lost their homes, he said.

"Clearly, the regulators caught them doing something wrong," he said, "and now they're trying to get some money out of them to do some proactive good and prevent foreclosures."

Of course, most of the money the banks would use to pay is accounted for already.

(Reporting By Rick Rothacker in Charlotte N.C.; Additional reporting by Aruna Viswanatha in Washington, D.C. Editing by Alwyn Scott and Gerald E. McCormick)

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Analysis: Obstacles high for more mortgage prosecutions (Reuters)

NEW YORK (Reuters) – Despite the determination of President Obama to take Wall Street to court for the financial crisis, prosecutors face an uphill struggle to win more convictions like the two they scored on Wednesday against former Credit Suisse Group AG (CSGN.VX) mortgage traders.

David Higgs, 42, and Salmaan Siddiqui, 36, pled guilty in U.S. District Court in New York to a criminal charge of conspiracy to falsify books and records and commit wire fraud in a way that bolstered their bonuses.

The convictions marked the first successful criminal prosecutions against individuals at investment banks involved in the meltdown, and took four years to win, even without a trial.

In building the case, prosecutors enjoyed advantages that are rarely available -- and likely make this kind of success hard to replicate.

Prosecutors drew on a trove of emails and taped telephone recordings from the traders that helped establish criminal intent. They also had price history on their side. The Credit Suisse traders placed unusually high values, or "marks," on their portfolio of bonds months after Citigroup (C.N) and Merrill Lynch each reported multi-billion-dollar losses on their portfolios of similar mortgage securities.

Credit Suisse in February of 2008 took a $2.85 billion write-down to adjust the value of these securities, known as collateralized debt obligations, on its books.

Prosecutors "got two people to plead guilty, so that suggests this is the lower-hanging fruit" of potential cases, said Robert Anello, a partner at Morvillo Abramowitz, a prominent white-collar defense firm in New York.

John Hueston, a lead prosecutor in the Enron trials who is now a white-collar defense lawyer, said that alleged improprieties in other financial-crisis cases will be much more difficult to dissect and prove.

"This kind of case is going to be the exception," said Hueston, a partner at Irell & Manella in Los Angeles, who represented Angelo Mozilo, former CEO of subprime lender Countrywide Financial Corp, in a criminal investigation that was dropped.

In pleading guilty, Higgs, who is cooperating with investigators, admitted in court that he had "manipulated and inflated" values he reported for a battered portfolio of mortgage bonds. He said he acted at the instruction of his former boss to hide losses and meet profit targets. Meeting the targets was essential to the team's bonuses.

Prosecutors have been less successful with Higgs' former boss, Kareem Serageldin, 38, an American living in London. Serageldin was indicted on the same conspiracy charge, plus other charges. His lawyer, James McGuire, said Wednesday that Serageldin believes he did nothing wrong. He said his client had given several interviews to investigators.

The Securities and Exchange Commission accused those men, along with a fourth Credit Suisse trader, Faisal Siddiqui, of violating civil laws. Asked why the fourth man had not also been charged criminally, U.S. Attorney Preet Bharara said that prosecutors must prove their cases beyond a reasonable doubt, which is a tougher standard than the SEC faces. Faisal Siddiqui, who is not related to Salmaan and was not charged with any criminal wrongdoing, could not be reached for comment.

"These cases are not easy to make," Bharara said. "Often such a criminal case can be made only with the help of cooperating witnesses on the inside of the financial institution, or incriminating recordings of misconduct."

In the only other high-profile criminal case to go to court, involving two former Bear Stearns hedge fund managers, a Brooklyn, N.Y., jury acquitted the men of charges of lying to their investors about the financial stability of funds that invested mainly in subprime securities. In another situation, prosecutors dropped a criminal investigation of the man who ran a division of American International Group Inc (AIG.N) that suffered losses on mortgage instruments that led to a government bailout.

The pressure to bring more cases is intense. Obama, in his recent State of the Union Address, said he would direct prosecutors to expand investigations into the dealings that led to the housing crisis.

"The government is trying hard to bring cases," said Jacob Frenkel, a former prosecutor, with Shulman Rogers in Potomac, Maryland.

Yet while these convictions may appear to follow rapidly on the president's speech, the case began before Obama took office.

And mispricing began even earlier. Keeping inflated marks on subprime securities was common once house prices started to slip in 2005, said Janet Tavakoli, a structured finance expert, said in an interview.

Prosecutors in the Credit Suisse case alleged that Higgs lamented in one phone conversation that values on securities in his portfolio in late 2006 had been too high.

The situation across Wall Street got worse at the start of 2007 when the market collapsed, Tavakoli said. "People just did not want to mark down their books."

But proving in criminal court that people at other firms inflated prices for mortgage securities would likely be more difficult than winning the two Credit Suisse convictions. Mortgage securities can be complicated and idiosyncratic, leaving room for people to disagree on how much they are worth.

"It is very hard to value them and very hard to show the criminal state of mind that is needed to bring a criminal case," said defense lawyer Anello.

Higgs, starting as early as August 2007, went to exceptional lengths to hide his losses at Credit Suisse, prosecutors said in a document filed with his guilty plea.

He built spreadsheets to justify his high marks on the roughly $3.5 billion portfolio as prices fell on widely followed market indexes for subprime securities, they alleged.

Dissatisfied with valuations provided by large banks, one of Higgs staff called a friend at a small investment bank to get endorsements for the inflated values, which were essential for traders' bonuses, prosecutors said.

By the time Credit Suisse uncovered and disclosed the inflated marks in February 2008, Higgs portfolio had lost $540 million.

Compared with valuations elsewhere on Wall Street, said Robert Khuzami, enforcement director at the SEC, the marks on the Credit Suisse portfolio "were outliers and artificially high."

(Reporting by David Henry and Lauren Tara LaCapra in New York, and Philip Shishkin in Washington.; Editing by Alwyn Scott)

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Analysis: Banks expect to spend less on bad mortgages (Reuters)

(Reuters) – Even as President Barack Obama is calling for more assistance for struggling mortgage borrowers, major banks are looking forward to spending less to handle problem home loans.

The chief executives of JPMorgan Chase & Co (JPM.N) and Bank of America Corp (BAC.N), the two biggest U.S. banks, said this month their rate of spending to handle troubled mortgages had topped out and should begin to decline soon with falling delinquency rates. Wells Fargo & Co (WFC.N), the fourth-biggest bank, also is counting on lower mortgage expenses this year.

With fewer problem loans to process, the banks could reduce the army of back-office staffers who handle the paperwork and phone calls required by foreclosures.

Bank executives are under pressure from investors to reduce expenses to improve profits amid weak demand for loans in the slow economy. If the three big banks are right in anticipating that the wave of mortgage defaults will subside, their bottom lines will get a lift -- and property values will firm up, to the benefit of neighborhoods across the country.

Others are not so optimistic. Executives of Citigroup Inc (C.N), the third-biggest bank, continue to caution that mortgage issues, including legal liability for alleged abuses, remain the biggest single threat to the U.S. banking industry. And some consumer advocates worry that the banks could scale back too quickly on their mortgage workout staff.

Obama, who said in his State of the Union address on Tuesday that he intends to ease the mortgage burdens of "millions of innocent Americans," is sending Congress a plan to allow homeowners to refinance at lower rates even when they owe more than their homes are worth. Also under discussion: a multistate settlement in which banks could pay up to $25 billion in exchange for protection from future lawsuits about improper foreclosures and lending and servicing abuses.

After the bust in house prices, the banks built up armies of staff to handle problem loans, said Guy Cecala, publisher of industry trade journal Inside Mortgage Finance.

"I'm not passing judgment on how well it works or how efficient it is," he said. "But they have adequate staffing."

JPMorgan nearly tripled its staff over three years to 20,000 people. "That number has probably peaked, and I think you will see it coming down over the next couple years," JPMorgan Chief Executive Jamie Dimon told analysts who questioned him about expenses after the company reported lower fourth-quarter profits.

Dimon forecast that two-thirds of the $925 million of expenses JPMorgan incurred to service mortgages in the quarter will go away.

JPMorgan's mortgage delinquencies are down sharply from 18 months ago, and the bank charged off less than half as much money for problem home loans in the fourth quarter as it did a year earlier.

Bank of America is working off a mountain of mortgage problems left from its 2008 purchase of subprime lender Countrywide Financial. It now has about 32,000 workers handling delinquent or other at-risk mortgage loans, more than six times the staff it had in 2008. The bank spent $2 billion in the fourth quarter, excluding litigation costs, on the issue.

Chief Executive Brian Moynihan said that over time that spending will be reduced to $300 million per quarter, even taking into account stricter servicing regulations faced by banks.

Moynihan noted that total loans more than 60 days past due declined more than 20 percent from a year earlier to about 1.1 million in the fourth quarter. He said the bank expects costs to decline in 2012 but that it could take up to two years for expenses to return to normal levels.

The resolution of problem loans will depend on how fast the economy improves and the unemployment rate declines, Bank of America spokesman Dan Frahm said. The bank will continue to make "investments necessary to meet the needs of our customers," he added.

San Francisco-based Wells Fargo told analysts it expects to reduce its quarterly expenses for troubled mortgages and foreclosures to as low as $600 million, compared with $718 million in the fourth quarter.

"We do believe that there are some cyclically high mortgage costs that are going to roll off," CEO John Stumpf told analysts.

Dan Alpert, managing partner with investment bank Westwood Capital LLC, said, "If the expectation is that the economy is strengthening and new defaults will start to slack off, then yes, expenses should go down."

But Alpert cautioned that if the economy is doing "a head fake, like in the first and second quarters of last year, then defaults will start going up again."

Diane Thompson, an attorney with the not-for-profit National Consumer Law Center, said it is premature for banks to say their operations are ready to be scaled back.

Banks continue to lose documents, give bad information to customers and take too long to resolve loan modification applications, said Thompson, whose organization assists struggling borrowers.

Banks could also have additional costs if they agree to new servicing standards to reach a settlement with federal officials and state attorneys general investigating alleged foreclosure abuses.

Some statistics suggest the foreclosure crisis is far from over. A study last fall by the Center for Responsible Lending estimated that while more than 2.7 million homeowners who received loans between 2004 and 2008 had already lost their homes to foreclosure, another 3.6 million were still at serious risk of ending up in the same boat.

Citigroup executives cautioned last week, for the second time in three months, that overall delinquency rates had stopped falling recently because some borrowers, who previously defaulted and had their mortgages modified, had defaulted again. Citigroup also said its servicing costs increased in the fourth quarter because it spent more to comply with a settlement banks reached last year with some regulators over the handling of mortgages.

"We continue to believe mortgage-related issues are the single largest source of risk facing the U.S. banking industry," Citigroup Chief Financial Officer John Gerspach told analysts.

Alongside servicing costs for existing mortgages and potential losses on the loans, banks also still face allegations that they broke laws during the housing boom by giving loans to unqualified borrowers and then fraudulently packaged and sold mortgage-backed bonds. Obama pledged Tuesday to ramp up government investigations of those allegations, which could lead to billions of dollars of litigation expenses and penalties for banks.

But Citigroup executives also noted that repeat defaults are

not as frequent as it had expected and that early-stage delinquencies were less common in the fourth quarter than in the third quarter.

Paul Miller, a bank analyst at FBR Capital Markets, said big banks' servicing expenses are likely to fall from current levels. But he cautioned that significant relief will not come as quickly as the banks would like.

"I would think 2012 is probably the year it peaks," Miller said, "but it's not like it's going down by 50 percent."

(Reporting By Rick Rothacker in Charlotte, North Carolina and David Henry in New York.; Editing by Alwyn Scott and John Wallace)

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Analysis - Bank of America's mortgage market share plunges (Reuters)

Charlotte, North Carolina (Reuters) – Bank of America (BAC.N) is set to lose nearly all the mortgage market share it gained by buying Countrywide Financial Corp in 2008, in the latest sign of how painful the acquisition has been for the bank.

The Charlotte, North Carolina bank said this month it is no longer buying mortgages made by smaller banks known as correspondent banks, which accounted for half of its mortgage volume.

Stripping out correspondent lending from the first half of the year would have left the bank's market share at about 8.5 percent, barely above its 7.8 percent market share before buying Countrywide, according to Inside Mortgage Finance data.

Bank of America's correspondent lending business came mainly from Countrywide, which was the largest U.S. mortgage lender when the bank bought it in 2008.

The $2.5 billion purchase saddled Bank of America with more than $30 billion of mortgage losses and legal costs, according to analysts.

"It's a total disaster," Guy Cecala, publisher of industry newsletter Inside Mortgage Finance, said of the deal.

In January 2008, the bank said the Countrywide acquisition would make it the largest U.S. mortgage lender and servicer, which would in turn make Bank of America the premier consumer lender overall.

Since then, the bank has lost mortgage market share from exiting businesses like subprime lending and lending through brokers. These types of loans helped make Countrywide the biggest U.S. mortgage lender but also triggered big credit losses for the company.

By giving up correspondent lending, Bank of America is likely to drop one spot to No. 3 in mortgage volume, behind Wells Fargo & Co (WFC.N), which has 25.7 percent of the market, and JPMorgan Chase & Co's (JPM.N) 12.7 percent.

In 2007, Bank of America was No. 5 in market share, while Countrywide was No. 1, with 16.8 percent market share.

By shedding correspondent lending, Bank of America is giving up a chance to buy loans made when underwriting standards are solid, Cecala said. The loans typically meet terms laid out by government-controlled mortgage giants Fannie Mae and Freddie Mac, or other government agencies.

But Dan Alpert, managing partner with investment bank Westwood Capital LLC, said Bank of America was making a smart move. These loans typically don't produce a lot of revenue for banks and can be of lesser quality. That's because smaller banks are originating the loans to be sold to other banks, which package them into securities for investors.

"By nature, you're going to be less cautious if someone down the line is buying the paper," he said.

WORST YEAR IN A DECADE

Banks are jostling for mortgage market share in a much smaller business now as the housing crisis wears on. Inside Mortgage Finance expects lenders to make about $1.2 trillion in loans this year, down from about $1.5 trillion last year and $2.4 trillion in 2007. "There is no question that 2011 will be worst mortgage lending year in a decade," Cecala said.

Bank of America spokesman Rick Simon said the bank will continue to focus on making loans directly to consumers, as part of its strategy to deepen relationships with the 58 million American households the bank does business with.

The bank's total share of the mortgage market will decline, but the bank is hoping to "offset some of the loss through the stronger retail focus," Simon said.

With Bank of America exiting the correspondent business, experts said smaller banks will likely sell loans to competitors and to Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB) instead.

Wells Fargo was the biggest correspondent lender in the first half of this year, with $56.3 billion in loans, accounting for 37 percent of its total originations.

(Editing by Steve Orlofsky)

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Analysis: Auditor defense may have holes in Deloitte case (Reuters)

NEW YORK (Reuters) – A favorite defense of auditors against securities lawsuits may have some holes when applied to a massive case against Deloitte Touche Tohmatsu Ltd stemming from the subprime mortgage crisis.

The world's largest accounting and consulting firm, Deloitte on Monday was accused of failing to detect fraud during its audits of Taylor, Bean & Whitaker Mortgage Corp, one of the biggest private mortgage firms to collapse during the U.S. housing crash.

The complaints were brought by a trustee overseeing Taylor Bean's bankruptcy and one of the company's subsidiaries in a Miami Circuit Court, claiming a combined $7.6 billion in losses.

"It's always difficult to believe that an auditor that's been auditing for seven years or more during an alleged ongoing fraud had no red flags," said Andrea Kim, a partner at Diamond McCarthy LLP in Houston.

The lawsuit is just the latest of a spate of troubles for Deloitte and the other big four auditors -- Ernst & Young, KPMG and PwC. They also face a threat to their business model as the European Commission mulls a plan to force them to split off their consulting business and rotate clients.

Auditors have been favorite targets of plaintiffs trying to recoup money lost on alleged frauds during the global financial meltdown, though such cases have run up against an array of legal hurdles, with many being dismissed or settled for relatively small amounts.

Plaintiffs' lawyers have argued that as gatekeepers, auditors have a duty to be vigilant at rooting out fraud.

RED FLAGS BRING LEGAL DUTY

"If they see something they need to report it," said Jacob Zamansky, founder of Zamansky & Associates, a law firm specializing in securities fraud. "If they consciously ignore red flags, they could be held responsible as an aider or abettor to the fraud."

A key defense is the so-called "in pari delicto," or equal fault principle, used when a company being audited was equally to blame for wrongdoing.

"It is very fast becoming a law of this nation, which is a tremendous protection for the Big Four," said Kim of Diamond McCarthy.

However, Steven Thomas, an attorney for the plaintiffs, said his case rests on solid legal ground. He said that a key bankruptcy decision holds that under Florida law, the in pari delicto defense does not apply in cases in which the auditor has a duty to detect fraud and in which there were innocent board members who could have been alerted about the fraud.

"They (Deloitte) had a public duty to detect the fraud," Thomas said. "They didn't do their job, and that's what we're going to prove."

Jonathan Gandal, a spokesman for Deloitte, said on Monday the plaintiffs in the case were "companies through which convicted felon Lee Farkas and his co-conspirators committed their crimes."

Lee Farkas, the former chairman of Taylor, Bean and Whitaker, was sentenced to 30 years in prison in April for his role in the bank fraud.

"The bizarre notion that his engines of theft are entitled to complain of injury from their own crimes and to sue the outside auditors they lied to defies common sense, not to mention the law," he said in a statement.

The in pari delicto principle, which has led to dismissals of some big auditor lawsuits in New York, "is alive and well in Florida," said Thomas Tew, a defense lawyer at the law firm Tew Cardenas in Miami.

In cases involving fraud, "I personally believe that it's almost impossible to say that an accounting firm, for instance, should be held liable for audits that were manipulated by crooks," he said.

DELOITTE NAMED IN OTHER SUITS

One complication for trustees is that when they bring a lawsuit, they "step into the shoes of the allegedly wrongdoing corporation," said Michael Young, a partner at Willkie Farr & Gallagher who specializes in accounting-related cases.

"So a trustee lawsuit against an auditor boils down to the contention that the auditor didn't tell the wrongdoing company that it was doing something wrong," Young said.

A key issue will be whether the Taylor Bean trustee can present itself as separate from the company, said Jeffrey Davis, a bankruptcy professor at the University of Florida's law school.

"It may be that the trustee can re-characterize their claim to get around the in pari delicto defense," said Davis. "That's the game that's afoot right now."

The EU's proposal to force the Big Four to split off their consulting business and rotate clients would affect all of the Big Four firms, but would be especially harsh for Deloitte, which just edged ahead of PwC as the biggest of the Big Four on the strength of its consulting revenues.

Deloitte has also been named in other big lawsuits stemming from the credit crisis, including one involving its audits of Bear Stearns, which collapsed after suffering enormous mortgage losses, and another involving Washington Mutual, the biggest bank to fail during the credit crisis.

Deloitte spokesman Gandal said the firm intends to defend the Bear Stearns case vigorously.

"These hindsight claims asserting that the independent auditors should have predicted the dramatic and unprecedented decline in the housing market that shocked the entire industry are meritless and illogical," Gandal said.

The Washington Mutual case has been settled in principle, he said.

(Additional reporting by Jonathan Stempel; Editing by Howard Goller)

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Analysis: Auditor defense may have holes in Deloitte case (Reuters)

NEW YORK (Reuters) – A favorite defense of auditors against securities lawsuits may have some holes when applied to a massive case against Deloitte Touche Tohmatsu Ltd stemming from the subprime mortgage crisis.

The world's largest accounting and consulting firm, Deloitte on Monday was accused of failing to detect fraud during its audits of Taylor, Bean & Whitaker Mortgage Corp, one of the biggest private mortgage firms to collapse during the U.S. housing crash.

The complaints were brought by a trustee overseeing Taylor Bean's bankruptcy and one of the company's subsidiaries in a Miami Circuit Court, claiming a combined $7.6 billion in losses.

"It's always difficult to believe that an auditor that's been auditing for seven years or more during an alleged ongoing fraud had no red flags," said Andrea Kim, a partner at Diamond McCarthy LLP in Houston.

The lawsuit is just the latest of a spate of troubles for Deloitte and the other big four auditors -- Ernst & Young, KPMG and PwC. They also face a threat to their business model as the European Commission mulls a plan to force them to split off their consulting business and rotate clients.

Auditors have been favorite targets of plaintiffs trying to recoup money lost on alleged frauds during the global financial meltdown, though such cases have run up against an array of legal hurdles, with many being dismissed or settled for relatively small amounts.

Plaintiffs' lawyers have argued that as gatekeepers, auditors have a duty to be vigilant at rooting out fraud.

RED FLAGS BRING LEGAL DUTY

"If they see something they need to report it," said Jacob Zamansky, founder of Zamansky & Associates, a law firm specializing in securities fraud. "If they consciously ignore red flags, they could be held responsible as an aider or abettor to the fraud."

A key defense is the so-called "in pari delicto," or equal fault principle, used when a company being audited was equally to blame for wrongdoing.

"It is very fast becoming a law of this nation, which is a tremendous protection for the Big Four," said Kim of Diamond McCarthy.

However, Steven Thomas, an attorney for the plaintiffs, said his case rests on solid legal ground. He said that a key bankruptcy decision holds that under Florida law, the in pari delicto defense does not apply in cases in which the auditor has a duty to detect fraud and in which there were innocent board members who could have been alerted about the fraud.

"They (Deloitte) had a public duty to detect the fraud," Thomas said. "They didn't do their job, and that's what we're going to prove."

Jonathan Gandal, a spokesman for Deloitte, said on Monday the plaintiffs in the case were "companies through which convicted felon Lee Farkas and his co-conspirators committed their crimes."

Lee Farkas, the former chairman of Taylor, Bean and Whitaker, was sentenced to 30 years in prison in April for his role in the bank fraud.

"The bizarre notion that his engines of theft are entitled to complain of injury from their own crimes and to sue the outside auditors they lied to defies common sense, not to mention the law," he said in a statement.

The in pari delicto principle, which has led to dismissals of some big auditor lawsuits in New York, "is alive and well in Florida," said Thomas Tew, a defense lawyer at the law firm Tew Cardenas in Miami.

In cases involving fraud, "I personally believe that it's almost impossible to say that an accounting firm, for instance, should be held liable for audits that were manipulated by crooks," he said.

DELOITTE NAMED IN OTHER SUITS

One complication for trustees is that when they bring a lawsuit, they "step into the shoes of the allegedly wrongdoing corporation," said Michael Young, a partner at Willkie Farr & Gallagher who specializes in accounting-related cases.

"So a trustee lawsuit against an auditor boils down to the contention that the auditor didn't tell the wrongdoing company that it was doing something wrong," Young said.

A key issue will be whether the Taylor Bean trustee can present itself as separate from the company, said Jeffrey Davis, a bankruptcy professor at the University of Florida's law school.

"It may be that the trustee can re-characterize their claim to get around the in pari delicto defense," said Davis. "That's the game that's afoot right now."

The EU's proposal to force the Big Four to split off their consulting business and rotate clients would affect all of the Big Four firms, but would be especially harsh for Deloitte, which just edged ahead of PwC as the biggest of the Big Four on the strength of its consulting revenues.

Deloitte has also been named in other big lawsuits stemming from the credit crisis, including one involving its audits of Bear Stearns, which collapsed after suffering enormous mortgage losses, and another involving Washington Mutual, the biggest bank to fail during the credit crisis.

Deloitte spokesman Gandal said the firm intends to defend the Bear Stearns case vigorously.

"These hindsight claims asserting that the independent auditors should have predicted the dramatic and unprecedented decline in the housing market that shocked the entire industry are meritless and illogical," Gandal said.

The Washington Mutual case has been settled in principle, he said.

(Additional reporting by Jonathan Stempel; Editing by Howard Goller)

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Analysis: Mortgage probe split puts banks in tactical bind (Reuters)

WASHINGTON (Reuters) – Large U.S. banks defending themselves against a mass of state and federal mortgage probes face a difficult tactical decision following New York state's exit from settlement talks on Tuesday.

A settlement with the states remaining at the negotiating table and their partner federal agencies may be easier to strike, and could give skittish investors a sense of the size of banks' liability.

But a partial deal would leave open the question of whether the more aggressive attorneys general will be able to extract their own massive settlements, analysts and industry lawyers said.

"The banks (have) got to be thinking what is the benefit of a deal with Iowa when New York and Massachusetts can still come after them," said a lawyer close to the process who asked not to be identified because of the sensitive nature of the talks.

Federal regulators and state AGs have been investigating bank mortgage and foreclosure practices that came to light last year, including the use of "robo-signers" to sign hundreds of unread foreclosure documents a day.

States and the departments of Justice and Housing and Urban Development have been negotiating for months with Bank of America, JPMorgan Chase, Citigroup, Wells Fargo and Ally Financial.

The uncertainty over banks' mortgage-related exposures has weighed heavily on their stocks. The KBW Bank Index of stocks is down about 30 percent this year. Shares in Bank of America, the largest U.S. bank by assets, are down about 50 percent.

A focus of the settlement talks is what type of legal protections banks will get for agreeing to change their practices and for paying a combined penalty of possibly around $20 billion.

The contentious issue has caused fissures within the block of states dealing with the banks.

New York Attorney General Eric Schneiderman has insisted that any deal should not preclude states from pursuing further cases against the banks related to their mortgage practices.

Iowa Attorney General Tom Miller, the states' lead negotiator, announced on Tuesday that Schneiderman had been booted from the committee working on the deal.

Miller said in a statement that in recent weeks "New York has actively worked to undermine" the multi-state groups work because of differences with how to proceed.

Schneiderman's office said he will continue to pursue a "comprehensive resolution" to mortgage problems.

New York could still sign on to a final deal negotiated by Miller's team, although that seems unlikely at the moment.

Analysts said Schneiderman's departure shows the remaining states, along with their partner federal agencies, are eager to strike a deal. It also could mean the settlement figure would be lower because fewer states may take part in the agreement, although government negotiators will fight to prevent it from dropping too much.

Guggenheim Securities LLC analyst Marty Mosby said even a more limited deal would likely help the banks because it would provide more certainty about the size and scope of the liabilities they face. "We go from guestimating to estimating," Mosby said. "The range of possibilities begins to narrow and you can get more comfortable."

A partial settlement may also help banks in their dealings with aggressive AGs like Schneiderman.

Gilbert Schwartz, partner at Schwartz & Ballen LLP and a former Federal Reserve lawyer who is not involved in the negotiations, said lenders could point to the settlement as a precedent both during negotiations with Schneiderman and in court.

"If he has to go his own way, the banks are just going to get their backs up and fight him," Schwartz said.

(Reporting by Dave Clarke; Editing by Tim Dobbyn)

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Analysis: How low can mortgage rates go? (Reuters)

NEW YORK (Reuters) – Mark Sass and his wife Jan decided to refinance the mortgage on their Cincinnati, Ohio, home on Friday, just days before the Federal Reserve pledged to keep rates near historic lows through the first half of 2013.

"I knew the Fed statement was coming out and rates had dropped to historically low levels, and it just seemed like an opportune time. I hadn't even thought about it until then," says Sass, who owns his own marketing research company.

Their original mortgage had a 20-year amortization period - at a 4.875 percent rate - with 12 years remaining. They are rolling it over into a 10-year mortgage with a 3.5 percent rate. "I was able to knock a couple of years off the term with a very modest increase in the monthly payment," Sass says. "It seemed like a no-brainer to me."

Sass and his wife are both 55, so retirement is on the horizon. "The opportunity to look 10 years out and know that - unless things change - we won't have a mortgage when we retire looked like a smart decision," Sass says, adding the overall savings on interest by reducing his term will be in the neighborhood of $20,000.

Sass is one of many jumping on the refinance bandwagon in the wake of the current financial crisis. Mortgage applications shot up 21.7 percent for the week ending August5, according to the Mortgage Bankers Association Market Composite Index. The spike was largely driven by a 30.4 percent jump in the group's refinancing index.

"In a few years, these rates will be a memory that people talk about at cocktail parties. Just like when our parents talked about how low interest rates were when they bought their homes," says Dan Nigro, principal at Warfield Consultants in Montclair, New Jersey. "These are the kind of levels that people should lock in for the long term and it certainly is what the government has in mind."

But the question remains: With the average rate on a 30-year fixed mortgage hovering just below 4.5 percent - the lowest levels for 2011 according to LendingTree.com - should consumers jump to refinance or buy a new home? Or should they wait for a new bottom?

Now is the time to act, says Alex Stenback, who writes at the blog "Behind the Mortgage" and is a mortgage banker with Residential Mortgage Group, a division of Alerus Financial. "Don't get lulled into a sense of complacency over what the Fed says about interest rates. They can move up, and this window can shut much faster than people imagine," he cautions.

Greg McBride, senior financial analyst at Bankrate.com, agrees. Since Standard & Poor's downgrade of the U.S. credit rating from AAA to AA on August 5, Treasury yields have fallen. "But mortgage rates aren't going down at the same pace," McBride says.

Mortgage rates tend to mirror long-term U.S. Treasury rates, which have declined in recent weeks. The benchmark 10-year Treasury note hovered around 2.12 percent late Wednesday and set a record low auction yield of 2.14 percent the same day.

If you're convinced now is a good time to refinance your existing mortgage, or buy a new home, here are some ways that traditional advice is playing out in today's market:

1. Shop around for your lender

Cast a wide net when looking for a lender. Do your research and look for alternatives. Check with your local credit union to see if you're eligible for a membership rather than getting lured by major institutions advertising low rates. The Internet offers an array of sites devised to help you find the best lender and rate for you. Bankrate.com's refinance section is a great place to start.

"You want to apply, ideally, with two to three different lenders on the same day. Rates change all the time and you want to facilitate an apples-to-apples comparison. If you apply on the same day, when you look at the good-faith estimates you can make a good comparison of not just the rate but also the fees that will be charged," McBride says.

Sometimes you need to play hardball. Ken McDonnell, director of the American Savings Education Council with the Employee Benefit Research Institute, refinanced his mortgage last week. After researching online, he contacted a number of lenders in his area and approached his mortgage holder with the best offer he found. "I contacted Bank of America, who was my mortgage banker for the past 13 years, and told them the rate I'm getting from Aurora Financial - 3.6 percent and $3,000 in closing costs - and asked could they match it or do better and they didn't," he says.

By switching lenders, McDonnell reduced his rate from 4.5 percent to 3.6 percent, which saves him $291 on his monthly mortgage payment.

2. Do your research on costs

Will the costs associated with refinancing justify the reduced monthly payment? The typical rule-of-thumb is a homeowner should refinance if they can save a full percentage point on their rate.

Bob Davis, executive vice president of the American Banker's Association, cautions against applying the broad-blanket, one-percent rule. Consumers need to consider individual costs to modify versus change lenders, annual savings on the reduced rate, how long you'll likely remain in the home, the change in an interest rate tax deduction, title insurance, escrow waiver fees and other charges.

"The cost of those variables may be different there is a break-even point there. It may take you three years to get back your out-of-pocket expenses. If you're planning on staying in your home seven years, than that's a good thing to do but if you're only staying in the home two years, it will cost you more to refinance," he says.

For McDonnell, the cost to change lenders was minimal. Two-thousand dollars of the $3,000 in costs were rolled into his mortgage, and after closing his escrow account with BofA, he received a $1,700 refund. "It's going to be a very small amount that's coming out of my pocket," he says.

In the unwritten rules of refinancing, your monthly mortgage payment savings should equal your closing costs within 12 to 18 months. In McDonnell's case, he'll break even in 11 months.

3. Request a copy of your credit report

While there may be an incredible incentive to refinance due to low rates, be sure your credit history is in order before approaching a lender.

To lock in the lowest rates, consumers will need a FICO score of at least 760 to even be a contender for refinancing, Nigro says. "These are very tight credit underwriting regulations and when you combine that with the fact that 25 percent of Americans have a loan-to-value that exceeds 125 percent of the value of their home, it means that a large amount of people are eligible to refinance but less than 20 percent of all of those who have the rate incentive can refinance because of their credit score and/or the equity they have in their home."

Everyone is entitled to a free annual credit report from each of the three nationwide credit agencies: Experian, Equifax and TransUnion. Log on to http://www.annualcreditreport.com for your quarterly update.

You never know, you may be pleasantly surprised by your credit score, says Sass. "Both of our kids are out of college, we have no credit card debt so I knew the (credit) score was going to be high. It makes life a lot easier and there are a lot less questions to answer."

(Editing by Beth Gladstone)

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Analysis: Mortgage tax break eyed to help cut debt (Reuters)

WASHINGTON (Reuters) – Lawmakers are eyeing a popular tax deduction for mortgage interest as they look for ways to fill record budget deficits, although any changes are likely to await a broad reworking of the tax code.

Two forces are conspiring in a way that could put the long-cherished deduction on the chopping block: a need to raise more revenues and a feeling among policymakers that government incentives for housing have been too generous.

"It's a confluence of several factors. First, it's such a large tax break," said Donald Marron, director of the Urban-Brookings Tax Policy Center. "And the tax treatment of housing is much more favorable than we provide for most other investments people undertake."

A bipartisan group of U.S. senators, known as the "Gang of Six," pushed a debt plan last week that embraced changing the deduction to help achieve $1 trillion in revenues and reduce deficits by nearly $4 trillion over the next decade.

The proposal comes as Democrats and Republicans rushed on Thursday to rework rival deficit reduction plans to avert a crippling U.S. default.

The government has allowed home buyers to deduct a portion of the interest paid on mortgages for decades as a way to promote home ownership.

Efforts to curtail the deduction have gained ground as a way to curb the nation's growing debt, and while the latest dueling deficit-cutting plans in Congress do not commit to take the tax break away, plans to curb it could resurface.

The plan left it to congressional committees to decide how the tax break would be trimmed, but any legislation should "reform, not eliminate" the deduction.

The deduction, which costs the U.S. Treasury about $100 billion a year, is the largest subsidy for homeowners and the nation's third-largest tax break, according to the Center for American Progress, a liberal policy research group.

About 35 million households claimed the mortgage interest deduction in 2009, according to the Joint Committee on Taxation, the congressional scorekeeper on taxes.

The deduction's popularity and its connection to the American dream of home ownership has made it sacrosanct politically. But that may have changed.

"There is more interest in the mortgage interest deduction, and it has more momentum than it has had in the past," said Brian Gardner, senior vice president for Washington research at Keefe Bruyette & Woods Inc.

TURNING DEDUCTION INTO TAX CREDIT

A presidential budget commission last year proposed turning the deduction into a 12 percent tax credit for buyers. The plan, which languished after being presented to Congress in December, would have capped the credit at $500,000 in mortgage debt and limited it to primary residences.

Gardner said Congress was more likely to revive that proposal than wipe out tax-related support for housing altogether.

However, he said any consideration of the measure would likely await a broader debate on tax reform -- and that will not heat up until lawmakers return from an August break.

"It's a tough issue to handle, and if it is not married to broader tax reform then it just becomes tougher."

Even then, the powerful housing industry lobby could persuade Republicans and Democrats alike to keep the deduction in place.

The Mortgage Bankers Association (MBA) and the National Association of Realtors are arguing that repeal would undermine a weak housing recovery.

"The mortgage interest deduction is important because it keeps the housing market functioning," said MBA President David Stevens. "We are very concerned about what would happen as the outcome to an industry that fuels 30 percent of gross domestic product if it was removed."

POST-BUBBLE BLUES

The deduction has frequently been criticized for providing a greater benefit to taxpayers with higher incomes than those further down the scale. The maximum amount of eligible mortgage debt for the deduction is currently $1 million.

However, John Weicher, director of the Hudson Institute's Center for Housing and Financial Markets, said a repeal would mostly pinch households with incomes between $75,000 and

$200,000.

Weicher, who served in the U.S. Department of Housing and Urban Development during the administration of former president George W. Bush said killing the deduction would not only harm the housing market but undermine the goal of fostering home ownership.

"It would put buyers at a disadvantage and create a new bias in the tax code that favors renting rather than owning your own home," he said.

But many analysts argue that incentives for home ownership need to be realigned to the prevent type of bubble that led to the devastating 2007-2009 financial crisis.

The U.S. home ownership rate peaked at 69.2 percent of the total U.S. population in 2004, according to the U.S. Census Bureau, as lax lending standards fueled home sales.

By the first quarter of this year, it dropped to 66.4 percent.

"There is a longstanding American emphasis on home ownership that has gone to extremes," Urban-Brookings' Marron said. "It is something that encourages people to take on a lot of mortgage debt. To be frank, mortgage debt isn't as popular today as it used to be."

(Editing by Jeffrey Benkoe)

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Analysis: BofA now needs to focus on Basel III levels (Reuters)

NEW YORK, July 1 (IFR) – Bank of America Corp's (BAC.N) decision to resolve $14 billion worth of mortgage backed securities-related liabilities might have boosted its stock and bond prices, but it has put it further behind its peers in the race to build up enough capital to be Basel III compliant.

BofA this week announced a settlement, still pending court approval, that makes changes to servicing practices and an $8.5 billion payment to the trustee, for 530 legacy Countrywide RMBS trusts.

Bank of America CEO, Brian Moynihan, said the sizable charge the bank is taking will impact Tier 1 ratios by about 50bp under Basel I standards. Analysts were told the expectation was for BofA to hold core Tier 1 common equity capital equivalent to 6.75%-7% of its risk-weighted assets (RWA) by the beginning of 2013.

That compares with Citigroup's (C.N) expectations of having around an 8-9% Tier 1 common equity ratio by that time. JPMorgan (JPM.N) says it is already at 7.3% common Tier 1 under Basel III guidelines and analysts expect it will be around 10% by the start of 2013.

According to Goldman Sachs, all of the largest US banks except Citi and BofA are today at or above a 7% Tier 1 common equity ratio on a fully-phased in Basel III basis, even though they don't have to even start implementing Basel III guidelines until January 2013. Citi is currently estimated to be around 6.1% and BofA around 5.4% under Basel III.

It doesn't have to be a race. Most analysts expect all of the largest US banks to be compliant by the 2019 implementation deadline if the Fed requires them to abide by all of the Basel III capital requirements, including the additional 1-2.5% Tier 1 common equity surcharge systemically important banks (G-SIBS) need. And that's without having to issue equity.

But in a world where markets and regulators are obsessed with bank strength - and Tier 1 capital being one of the most focused-upon gauges of strength - bankers and analysts argue that no-one wants to be the slowest to get there.

"We peg BofA's current Tier 1 common ratio under Basel III at 5.5% versus JPM and (Wells Fargo) (WFC.N) at over 7%," said Jason Goldberg, a senior Barclays Capital equity analyst. "We wonder if this difference is sustainable."

By sustainable, Goldberg is referring to whether shareholders will be patient with BofA or any bank if there's a persistently large gap between it and its peers in getting to Basel III compliance on capital.

Pressure could come on a bank's stock if it seems to be having a harder time meeting the new capital requirements as quickly as its peers. That's because its slowness could imply the bank will have to retain more earnings and have less ability to buy back shares and increase dividend payments in the future.

"Banks have to get there sooner," added a financial institutions group banker about reaching Basel III guidelines by 2019. "That's because of the equity pressure on banks to say to the market that they have the adequate capital. As we all know there is a race among the banks to not be the one singled out as having an issue with this."

Normally a bank would be better off phasing the new capital ratios in over time. "But in this environment it is all optics," said the FIG banker. "You have to say you can get to levels ahead of time because the view is it will make big clients think of you as the strongest and best bank to give their business to."

Although a bank's stock price and bonds spreads are rarely correlated, bankers say enough noise around the stock has the potential to trickle into the credit markets and cause a bank's funding costs to rise.

Goldberg at Barclays believes BofA's 'capital redeployment' - giving shareholders value through dividend increases and share buybacks - "will now be constrained for the foreseeable future, longer than its peers."

BofA has the ability to pick up the pace by retaining earnings and speeding up the 'mitigation' process, which involves shrinking RWA and freeing up capital through various measures.

Morgan Stanley analyst Betsy Graseck, argues that BofA can get to a 10% Basel III common equity Tier 1 ratio in 2013 sometime.

"Over the next three years, we expect 300bp to come from earnings, 110bp from RWA shrinkage, 110bp from reduced capital deductions, 40bp from a gain on CCB's (China Construction Bank) sale" and another 40bp from other methods, said Graseck in a recent report.

It's not just an unofficial race among competitors that's putting pressure on banks to get to Basel III compliance as quickly as possible.

The Bank for International Settlements (BIS) has said that banks should be pushed to meet the higher capital requirements before the series of phase-in deadlines start in 2013, as long as it doesn't affect a bank's ability to lend.

"Countries should move faster if their banks are profitable and are able to apply the standards without having to restrict credit," the Basel-based BIS said in its latest annual report. The BIS is the parent organization of the Basel Committee.

If they want to immediately get to 9.5% - the 7% minimum and the 2.5% G-SIB surcharge they're likely to need - Barclays estimates Wells Fargo, JPM, Citi and BofA would need about $175bn of extra capital. That's before mitigation actions they could take.

In reality the biggest banks might decide to have an extra 50bp more Tier 1 common equity than the 7% minimum and the likely 2.5% G-SIB surcharge.

"Given the need to have some room above the required capital levels due to potential volatility of other comprehensive income, we are modeling these companies (Citi, BOFA and JPM) to a target tier 1 common ratio near 10%," said Keefe, Bruyette & Woods analysts in a recent report. It is doing the same for Goldman Sachs and Morgan Stanley.

Basel III also calls for an additional 1.5% of non-common equity Tier 1, bringing the biggest banks' total Tier 1 capital needs up to a potential 11% and possibly 11.5% if they want to have the extra 50bp so they're not skating on the edge of the minimums.

The exact requirements, and what instruments can be used to fill them, will be outlined by the Fed in the late summer/early fall when it's expected to issue a notice of proposed rulemaking on how US banks should implement Basel III.

The battle then is expected to be focused on stopping the Fed from imposing any further capital buffers.

The arguments will center on the fact that Dodd-Frank regulations will impose additional costs and anti-competitive constraints on the US banks that their global competitors currently don't face. They are also likely to point out that the US's calculation of risk weighted assets is stricter than what it is in Europe.

(Danielle Robinson is a senior IFR analyst)

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Analysis: Obama claim shutdown to hit housing may be off mark (Reuters)

By Corbett B. Daly Corbett B. Daly – Thu Apr 7, 3:56 pm ET

WASHINGTON (Reuters) – President Barack Obama's warning that a government shutdown might prevent many Americans from obtaining a mortgage may be more of a negotiating tactic than reality.

Obama and House of Representatives Speaker John Boehner on Thursday raced against a midnight Friday deadline to craft a budget deal that would cut billions of dollars in spending and keep the government open.

A shutdown is not without risks. But unless it drags on for many weeks -- an unlikely worst-case scenario -- home buyers would probably see little more than a brief delay in processing mortgages.

If the government does shut down, the Federal Housing Administration would close its doors. That means thousands of Americans looking to buy a house with an FHA-backed loan would not be able get a case number for their loan, and the lender would not be able to process certain paperwork for the government-backed insurance.

"It may turn out that somebody who was trying to get a mortgage can't have their paperwork processed by the FHA and now the person who was going to sell the house, what they were counting on, they can't get it," Obama said on Wednesday.

What Obama did not tell his town-hall audience is that the banks making decisions about whether to grant the loan could continue to work with borrowers while the government is closed, dealing with the paperwork as soon as the government reopens, even retroactively.

The FHA's role supporting the mortgage market has ballooned as private credit tightened in the wake of the housing bust, making Obama's argument seem compelling.

The agency now insures about one-third of all new home purchase loans, compared with less than 4 percent before the housing market soured, according to the publication Inside Mortgage Finance.

That's more than 7,500 new FHA-backed mortgages issued every business day, according to Guy Cecala, the newsletter's publisher.

But the nation's biggest mortgage lenders, including Wells Fargo, Citigroup, JPMorgan Chase and Bank of America, have all been given authority to make FHA-backed loans without the FHA checking each loan.

The FHA guarantees loans that meet certain conditions but does not make loans directly.

"Unless the shutdown lasted more than a couple of weeks, it should not delay FHA activity," said Cecala, "Two weeks is not a huge ton of time in the mortgage business."

Still, the paperwork snafu could lower the April sales volume if some of those loans that would have closed in April end up closing in May.

While some number of deals could be scuppered, White House and HUD officials said the Obama administration did not have any estimates for how many.

Still, a temporary shutdown of FHA does come with risks.

Adam Levitin, a professor at Georgetown University who closely follows the housing sector, said the psychological effect of temporarily lower sales figures could further depress an already floundering market at the height of the selling season.

"This is a really bad time to have a hiccup in the market," said Levitin.

The two largest providers of residential mortgage funds, Fannie Mae and Freddie Mac, would not be affected by a shutdown as they are technically private firms.

(Additional reporting by Alister Bull; Editing by Andrew Hay)

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