Bank of America Corp. may face billions of dollars more in liability for faulty mortgages if a judge agrees with the insurer MBIA Inc. that the lender must buy back loans even if the errors didn't cause a borrower's default.
If New York Supreme Court Justice Eileen Bransten and judges in similar cases across the country rule that the issue of "causation" doesn't apply — meaning it's enough to show that the loan was improperly made — it "could significantly impact" Bank of America's potential costs, the bank said in a regulatory filing this month.
Such court defeats may add as much as $9 billion to what B of A owes bond insurers, according to the hedge fund Branch Hill Capital, which is betting against its stock and has invested in MBIA, of Armonk, N.Y. A victory for MBIA may also strengthen claims by mortgage securities investors that want the Charlotte, N.C., bank to pay more than the $8.5 billion it's offered them as a settlement.
"You don't have to wait until you're in a severe accident before you return the car with bad brakes," said David Grais, a partner in New York at Grais & Ellsworth LLP who represents investors objecting to the bank's proposed settlement with Countrywide Financial Corp. mortgage bond holders.
Any ruling on the issue, which was to be the subject of a hearing Friday in state court in Manhattan, may come later than expected because the proceeding was postponed until October. The decision may intensify settlement talks between bond insurers like MBIA and other banks that issued securities based on faulty mortgages, according to the head of the insurer Assured Guaranty Ltd., which is demanding money from lenders including UBS AG and Credit Suisse Group AG.
"If they lose that case, then our certainty of getting reimbursed becomes a lot higher," Dominic Frederico, Assured's chief executive, said in an interview. B of A agreed in April to a deal it valued at $1.6 billion with Assured, of Hamilton, Bermuda, to settle its mortgage claims.
Since the start of 2010, B of A's cushion for future losses on repurchases of mortgages that never matched their promised quality has ballooned from $4 billion to $17.8 billion even as it made payments in settlements with debt guarantors such as Fannie Mae and Freddie Mac, the government-supported mortgage giants.
The bank set aside $14 billion last quarter to cover claims, including the proposed $8.5 billion for the Countrywide bond settlement reached in June with investors including BlackRock Inc., the Federal Reserve Bank of New York and Pacific Investment Management Co. The deal is being challenged by other bondholders and attorneys general in New York and Delaware.
Its reserves and guidance on how much more it may need are based on several assumptions, though, including the company's view that losses will only have to be reimbursed if it can be proven "that the alleged representations and warranties breach was the cause of the loss," the bank said in the Aug. 4 filing with the Securities and Exchange Commission. If courts disagree, "it could significantly impact" the estimate of as much as $5 billion in additional liabilities.
"It could change the playing field," MBIA's chief executive, Jay Brown, said on an Aug. 10 conference call with analysts and investors when asked about the causation issue. It could "have a very significant effect on the ability to rescind or obtain rescissionary damages," he said. "So, it can affect the view of both parties as to the likely outcome of the trial."
Lawrence Grayson, a spokesman for B of A, said in an email that Branch Hill Capital "consistently has overstated Bank of America's representation and warranty repurchase exposure."
"Their motives are not nuanced," he said. "Less than a year ago, they had estimated repurchase losses for Bank of America of approximately $74 billion. They were wrong then, and we believe that they are wrong now."
The company has provisions for all exposure that "currently is probable and reasonably estimable," he said.
In December, Bransten denied B of A's bid to prevent MBIA from using reviews of samples of loans in the case, rather than requiring reviews of every individual mortgage in dispute. The ruling may add to the threats facing B of A by encouraging suits, according to the SEC filing.
B of A Vice Chairman Charles H. Noski said on an October conference call that the bank had the "resources to deploy" in "defending the interests of our shareholders" through loan-by-loan fights. On the same call, he sought to reassure investors that its losses would be minimized by contract language specifying when the lender would be required to repurchase faulty loans.
"Many of the losses observed in these deals have been, and continue to be, driven by external factors, like the substantial depreciation in home prices, persistently high unemployment and other economic trends, diminishing the likelihood that any loan defect, assuming one exists at all, was the cause of the loan's default," said Noski, then the bank's chief financial officer.
B of A's ultimate liability is difficult to assess because the matter is likely to be settled, said Jonathan Hatcher, a credit strategist at Jefferies Group Inc. who covers financial companies.
B of A is among lenders suing MBIA to overturn a 2009 split of the insurer that the bank said left the unit guaranteeing mortgage bonds insolvent.
"The whole thing is literally a negotiation," Hatcher said of the multiple threads of litigation. "That makes it difficult to assess what the number would be."