Bank Of America Made $204 Million Because It Sold Bad Mortgages More Than 6 Years Ago

A win for Deutsche Bank in a mortgage lawsuit protects other lenders of questionable securities

Bank of America brought in $22.3 billion in revenue in the second quarter. Its profit -- $5.3 billion -- was almost double compared to this time last year, CEO Brian Moynihan said, because expenses were lower and the bank made more loans and originated more mortgages amid an improving U.S. economy. 

But a small slice of BofA's earnings boost, $204 million, came from a relatively obscure New York court case about an even more obscure pre-crisis mortgage deal.

The transaction in question is generally referred to simply as ACE. ACE was a 2006 residential mortgage-backed security whose full name is ACE Securities Corp., Home Equity Loan Trust, Series 2006–SL2, because that's the sort of unwieldy jumble of a name banks gave mortgage securities in 2006. Also, because ACE was a mortgage security issued in 2006, it turned out to be filled with a lot of really bad mortgages. The mortgages in ACE were so bad -- 2,375 of 5,000 loans were allegedly misrepresented -- that the investors who bought the security sued the unit of Deutsche Bank that sold it. But it took them until 2012 to realize that and file a lawsuit against Deutsche -- just over six years after the deal was done. 

And that was the problem: the statute of limitations to sue the seller in this kind of security is six years. But when do those six years start? Deutsche argued they began when the deal was done in 2006. The investors argued that they began when Deutsche refused to buy back the bad loans as a way to solve the disagreement in 2012. 

The question was finally settled last month when a New York judge ruled that the statute of limitations began in 2006. The investors who'd bought what was now plainly junk were out of luck. Had they realized the mortgages weren't quite what Deutsche said they were just a year earlier, or -- as you might expect of sophisticated institutional investors -- when they were buying them in 2006, they'd have a case. But not now.

Deutsche's victory wasn't solely its own, of course. It was also a boon for anyone who had sold junked-out mortgage securities in the years before those securities sparked the financial crisis in 2008. Bank of America and especially Countrywide, the lender it acquired in 2007, sold plenty of dilapidated mortgages that were wrapped into securities in the runup to the crisis. (BofA settled with the Justice Department and various state attorneys general for $16.65 billion in 2014).

Deutsche's win meant BofA no longer needed to hold $204 million in reserve to fend against certain kinds of lawsuits. (Or, in the bank's own words, "The most recent quarter included a net benefit of $204 million in representations and warranty provision.") 

And so, in a roundabout way, Deutsche Bank's lawyers made Bank of America's rosy quarter a just a bit better.