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* Talks have become constructive, but settlement not imminent
* Bank, Fannie fighting over requests to buy back soured mortgages
* Bank's total claims increased by more than 40 percent in second quarter
By Rick Rothacker
Aug 2 (Reuters) - Bank of America Corp is in talks with Fannie Mae to resolve a dispute over bad mortgages that the government-controlled entity wants the No. 2 U.S. bank to buy back, sources familiar with the matter said.
The two sides have been in discussions for some time, but the talks have become more constructive recently, the sources said, although they cautioned a resolution is not imminent.
At issue are billions of dollars of mortgages that Bank of America and its Countrywide Financial subsidiary sold to Fannie Mae from 2004 to 2008, during the U.S. housing boom. As the loans go bad, Fannie wants Bank of America to buy them back.
Bank of America has balked at buying back some of the loans. In recent quarters, it has said that Fannie Mae is increasingly asking it to purchase loans in which borrowers made payments for more than two years or that went bad more than a year-and-a-half earlier.
The bank contends these loans soured due to economic conditions and other reasons rather than poor underwriting or lack of proper documentation, which are common causes for repurchase requests.
The dispute has become so tense that at the end of January, Fannie did not renew a contract with Bank of America to buy some of its home loans. The bank still sells mortgages to Freddie Mac and keeps loans in its own portfolio.
Bank of America and Fannie Mae declined to comment. In its most recent quarterly filing, in May, Fannie Mae said it continued to work with Bank of America to resolve the issue, but hadn't changed its estimates of the amounts it ultimately expected to collect from the bank.
During the bank's earnings conference call last month, Chief Financial Officer Bruce Thompson said the spat would either end in a settlement or legal action.
Other banks have said that Fannie Mae and Freddie Mac have been asking them to buy back more loans, but the problem is most acute for Bank of America. That's because in 2008 it bought subprime lender Countrywide, which produced some of the most toxic loans during the housing bubble.
Bank of America last month said total repurchase requests outstanding increased more than 40 percent to $22.7 billion in the second quarter from the first quarter, spurring investor concern that the bank will be on the hook for more mortgage-related losses.
Claims from Fannie Mae and Freddie Mac represented a little less than half of the total. Claims from private investors that bought loans from the bank also jumped.
Bank of America has about $16 billion in reserves set aside for these claims, which includes money to cover an $8.5 billion settlement reached in 2011 with private investors that bought securities backed by Countrywide loans. That agreement still needs court approval.
The bank's executives have cautioned that the $22.7 billion in claims doesn't represent potential losses for the bank but simply the unpaid balances of the loans in question. Those loans are backed by collateral, and in settlement agreements the bank has typically paid pennies on the dollar of actual losses.
The bank, however, has said more claims could still come in from the government-controlled entities and private investors.
In a report this week, Bernstein analyst John McDonald estimated that Bank of America has worked through about two-thirds of its potential repurchase requests and that it may eventually pay another $5 billion above its existing reserves. The bank has also estimated that it could pay an additional $5 billion above its reserves.
In the report, McDonald also said he assumed that one of the private investors that has requested the bank to buy back mortgages is actually Fannie Mae or Freddie Mac. That's because the government-controlled entities also bought so-called private-label mortgage-backed securities for their own portfolios.
Fannie Mae and Freddie Mac said they are looking out for U.S. taxpayers in making repurchase requests. That's because the two entities were placed into government conservatorship in 2008 as their losses ballooned. Fannie has said in a securities filing that it may need more funds from the U.S. Treasury if it collects less than expected from Bank of America.
Bank of America has far more Fannie Mae mortgage repurchase requests than any other bank. As of March 31, it accounted for 58 percent of the entity's total, according to Fannie's most recent quarterly securities filing. The bank with the second most requests, JPMorgan Chase & Co, accounted for 10 percent of the total.