Banks have taken a public flogging for allegedly causing the worst financial crisis in decades. Now, investors may have an opportunity to literally make them pay for their mistakes.
A security called Rescap Liquidating Trust, which isn't technically a stock but can be bought through a regular brokerage account, was created precisely for the purpose of suing banks that originated poorly performing mortgages in the years leading up to the crisis. Investors in the trust are entitled to any litigation proceeds Rescap recovers from billions of dollars in claims against several dozen banks. Units of the trust, which has a market capitalization of $1.8 billion, have soared 127 percent since listing in January.
Where did Rescap come from? The trust was originally a company focused on securitizing mortgages and packaging them into units to be sold to investors. Many of those residential-mortgage backed securities, or RMBS, plummeted in value during the financial crisis. Holders of the RMBS sued Rescap's predecessor, Residential Capital, which filed for bankruptcy in 2012.
While Rescap's stakeholders have received some payments, there remains a potential opportunity for Rescap to sue the banks that originated the mortgages. The creation of the publicly traded trust allowed stakeholders to wait for the outcome of the lawsuits or simply sell their units and move on.
Several hedge funders saw plenty of value in Rescap. One of them was John Paulson, who famously made billions during the crisis by betting against mortage-backed securities. In a March investor letter, Paulson explained that he has had his eye on Rescap since 2008, when he made a bond investment in Rescap's parent. In December, just before Rescap began to trade, Paulson privately purchased a "large position" in the trust from an insurance company, according to the letter. A spokesman for Paulson declined to comment.
Is there any more upside in Rescap? The trust trades at $17.75 per unit, but a portion of that value isn't related to litigation and consists mainly of cash and securities on its balance sheet. According to its first quarter filing, the trust had $7.07 per share in net asset value. The remaining $10, or roughly $1 billion in market value, reflects expectations for proceeds from litigation against the banks.
Investors who own Rescap say there is much more than $1 billion in potential litigation proceeds, so the trust should trade at a higher value. Indeed, a disclosure statement from Rescap indicates claims of more than $7 billion.
Of course, it won't be possible to litigate for the full amount because some banks went bankrupt during the crisis. Investors in Rescap acknowledge that the amount of litigation proceeds should be adjusted to account for banks that are no longer going concerns. A lawyer representing Rescap declined to comment to CNBC.
Even so, Rescap's website lists dozens of active lawsuits against banks that are still around, such as Wells Fargo. That suit pertains to mortgages originated by Wachovia, now part of Wells Fargo. In a publicly available document, a Rescap affiliate alleges that the "defendant beached … representations and warranties by delivering loans that were not originated or underwritten in accordance with the requirements of the agreement." A spokesman for Wells Fargo declined to comment on the case, which remains open.
It's hard to gauge the odds for Rescap's success in the lawsuits. They are the first cases of this type filed by Rescap, and no decisions or settlements have been reached, according to a person familiar with the matter.
But Rescap offers something that should appeal to investors who want less exposure to the vicissitudes of the stock market. Given that the value of the units depends almost entirely on the outcome of litigation, Rescap should have very little correlation to the broader market. Indeed, Rescap has risen steadily in recent months while the market has seen bursts of volatility.
Investors should be careful about betting on Rescap's success, especially given that it hasn't yet won any cases. But with the market recently offering few opportunities to win, exotic investments like Rescap may keep their appeal for some time.