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Lehman Brothers Ghost Haunts Bank Foreclosure Deal: Street Whispers

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Over four years after the failure of investment bank Lehman Brothers, its ghost reappeared on Monday, in an $8.5 billion settlement between ten of the nation's top mortgage servicers, the Federal Reserve, and the Office of Controller of Currency (OCC) on improper foreclosure practices between 2009 and 2010.

While lenders such as Bank of America (NYSE:BAC), Wells Fargo (NYSE:WFC), and Citigroup (NYSE:C) appear to be taking the financial brunt of the settlement -- some banks haven't disclosed their costs -- a less heralded part of the deal involves Aurora Bank, the former loan origination and servicing unit of Lehman Brothers, and underscores that lingering risks of the housing bust still hang over the nation's top lenders.

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Through Colorado-based Aurora, Lehman Brothers originated risky "no-doc" mortgages it would eventually package into private label securities and sell off to Wall Street investors, in a housing bubble business model that mirrored a similar set up at competitors Goldman Sachs (NYSE:GS), Bear Stearns, and Merrill Lynch.

When the housing market stalled, the Wall Street investment banks were left holding billions in poorly underwritten loans that couldn't be sold off to investors of government sponsored agencies like Fannie Mae (OTC:FNMA). Few survived.

But the story of Lehman Brothers' disastrous foray into the mortgage market didn't end with the firm's September 15, 2008 bankruptcy. Instead of being placed into receivership by the Federal Deposit Insurance Corporation, Aurora Bank and its loan servicing unit became an asset held by Lehman's bankruptcy estate

It's while in the management of Lehman's bankruptcy process that Aurora's improper foreclosure practices appear to have occurred. The Fed and OCC settlement states that the foreclosure review is for actions taken between 2009 and 2010, when Aurora was being managed by Lehman Brothers estate, restructuring specialist Alvarez & Marsal.

Only in 2011 did A&M get the approval of a bankruptcy court to divest Aurora Bank, in a move geared at recovering some losses from Lehman's bankruptcy for the investment bank's creditors.

In 2012, well after the Fed and OCC opened their foreclosure review, called the Independent Foreclosure Review, A&M sold of Aurora Bank to New York Community Bank (NYSE:NYCB) and its loan servicing arm to Nationstar Mortgage (NYSE:NSM), a servicer that coincidentally announced on Monday a deal to buy up servicing assets from Bank of America.

As part of the Aurora deal, NYCB bought up $2.3 billion in Lehman's FDIC insured deposits in April 2012, and Nationstar bought $63.7 billion in servicing rights of Aurora Loans Services loan portfolio, which was skewed 75% non-conforming in private label securitizations and 25% conforming for government sponsored entities.

It means that while Aurora's Fed and OCC settlement doesn't involve the estate of Lehman Brothers financially, the improper foreclosure practices outlined in the review came when the firm was in its post Chapter 11 zombie state.

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