Bank of America's law firm defending the company against MBIA in a dispute over defective mortgages said that a court ruling in a separate case means lenders should reevaluate their reserves for bad loans.

Lenders could be forced to repurchase shoddy mortgages even if banks' misrepresentations weren't responsible for defaults, O'Melveny & Myers LLP said in a client note on its website. The law firm cited a June 19 ruling in which the judge sided with bond insurer Syncora Holdings Ltd. against a mortgage company.

"In light of a recent federal court ruling, banks may wish to reevaluate litigation risk from plaintiff insurers claiming injury" in bonds they backed, Robert Stern, an O'Melveny partner, said in the note dated July 27. Firms "facing such lawsuits may wish to reevaluate their exposure and possibly adjust reserves set aside to cover such risks."

The Syncora ruling contrasts with Bank of America's (BAC) argument that bond insurers and other firms should only win refunds if they prove that loan defects led to defaults. While Chief Executive Officer Brian T. Moynihan committed more than $40 billion to clean up mortgages at the second-biggest U.S. lender, he has yet to resolve disagreements with MBIA, whose claims make it one of the bank's biggest remaining adversaries.

"What's shocking about the O'Melveny note is that they represent Bank of America in the MBIA litigation; it's not like they are confused about the type of claims or the nature of the contract," said Manal Mehta, founder of San Francisco-based hedge fund Sunesis Capital, which owns MBIA stock. "They've come out very explicitly and said, ‘Hey guys, loss-causation is a game changer for your reserves."

Reserve Decisions

The note "was not a commentary on any institution's reserve decisions," said Majory Appel, a spokeswoman for O'Melveny & Myers. Lawrence Grayson, a spokesman for Charlotte, North Carolina-based Bank of America, declined to comment on the law firm's note.

Stern has represented a subprime lender and U.S.-owned mortgage firm in disputes over loans, according to the law firm's website. Appel declined to say whether Stern was involved in the MBIA case.

Bank of America had outstanding claims from the so-called monoline insurers on $3.1 billion of mortgages as of June 30, "substantially all" of which the lender has refused to repurchase after its assessment of whether valid defects exist, the firm said this month in a filing.

Outstanding Demands

The bank's interpretation is that it only has to buy back a loan if an underwriting error or misrepresentation "was the cause of the loss," Moynihan's firm said in the filing. Otherwise the company would be paying for defaults tied to the economic slump, a risk that should be handled by the insurer, the bank has said.

Rising demands from other firms, including U.S.-owned Fannie Mae and private investors, pushed the lender's total outstanding demands for mortgage buybacks more than 40 percent higher to $22.7 billion in the second quarter. That figure is the total unpaid principal balance of loans, and actual losses have been a fraction of the demands.

Bank of America expected the claims and set aside funds a year earlier, Chief Financial Officer Bruce R. Thompson said last month during a conference call. The company had $15.9 billion in repurchase reserves as of June 30 and an unspecified amount for litigation. Costs for all of the bank's litigation may exceed reserves by as much as $4.1 billion, the firm said.

The lender's calculations are based on assumptions, including about the prior behavior of counterparties, that may shift as Fannie Mae pushes for more refunds. Bank of America's costs could also rise if courts disagree with its arguments, the lender has said. Costs tied to private investors and insurers could be as much as $5 billion beyond its existing reserve, the lender has said.

Countrywide Losses

Bond insurer lawsuits are part of the fallout from Bank of America's 2008 takeover of Countrywide Financial Corp., whose lax standards and subprime loans were blamed by lawmakers and regulators for helping to fuel the housing bubble. The insurers say they should be reimbursed for claims they paid on securitized pools of home equity lines of credit because of Countrywide's flawed underwriting.

Bank of America has had settlement discussions with MBIA, FGIC Corp. and Ambac Financial Group Inc., according to two people with direct knowledge of the talks. Negotiations with MBIA are the furthest apart because bank managers think that Armonk, New York-based MBIA's demands are too high and the dispute is the most complicated, the people said. Attempts to reach FGIC and Ambac for comment weren't immediately successful.

The bank has already reached settlements with Assured Guaranty Ltd. and Syncora. The deal with Assured was valued last year at $1.6 billion, and the Syncora agreement announced last month cost Bank of America about $400 million.

Estimated Recoveries

The lender appealed New York State Supreme Court Justice Eileen Bransten's Jan. 3 ruling that MBIA need only show Countrywide made misrepresentations about the loans, instead of also establishing they caused the losses the bond insurer is seeking to recover. Bransten also rejected the insurer's request to decide the case in its favor without a trial, which MBIA is appealing. Kevin Brown, a spokesman for MBIA, declined to comment.

MBIA is depending on funds from Bank of America. The firm has booked $3.2 billion in estimated recoveries on its balance sheet for all mortgage-bond repurchase claims as of the end of the first quarter. The company also said it is entitled to be made whole on $4.8 billion in losses on transactions.

Equal Application

The O'Melveny note focuses on a June 19 ruling in Manhattan that lowered hurdles for insurers who say they were misled into covering securities by mortgage originators. The court agreed with Syncora in several arguments against EMC Mortgage Corp., a former unit of Bear Stearns Cos., which was bought by JPMorgan Chase & Co. in 2008. The ruling also states insurers can force banks to buy back loans where borrowers are making payments.

"There are many dozens, if not hundreds, of lawsuits against mortgage originators, seeking hundreds of billions of dollars due to alleged misrepresentations about the quality of mortgages sold into securitizations," Stern said in his note. Other plaintiffs "will undoubtedly argue that the Syncora decision should apply equally in those cases."

The case is MBIA Insurance v. Countrywide Home Loans, 602825-08, New York State Supreme Court (New York County).

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