Ever since private-label mortgage-backed securities litigation began, aggrieved investors have faced an uneasy trade-off between cost and thoroughness: They must prove their losses stem from systemic underwriting flaws, but they can ill afford the time and money required to bicker over how each loan was underwritten.
A ruling on an evidentiary matter in New York state court late last month increases the prospect that they won't have to. But, as is often the case with private-label mortgage-security litigation, the plaintiff's victory may lead to yet another protracted fight.
"The use of sampling does not obviate plaintiff's need to prove each element of its claims for breach of contract or fraud," wrote judge Eileen Bransten in the case brought by MBIA Insurance Corp. against Bank of America Corp.'s Countrywide home loan unit. "Defendants have raised significant valid challenges to plaintiff's methodology; however the court finds that such challenges are premature to decide here."
Bransten, of the New York Supreme Court, ruled on Dec. 22 that MBIA can use statistical sampling of loans to pursue its case against the former Countrywide Financial Corp.
The decision allows MBIA to look at a sample of 6,000 loan files from 15 residential mortgage-backed securities, rather than all the 368,000 files that are in dispute.
MBIA is hoping to win back billions of dollars it paid in insurance on mortgage-backed securities. The insurer is suing mortgage loan originators for allegedly failing to live up to underwriting standards on loans that were pooled, securitized, and insured by MBIA.
There is no question that the ruling is a significant loss for Bank of America, which had argued that the sampling method would "effectively attempt to co-opt the court as co-counsel for" the plaintiff MBIA Inc.
Brian T. Moynihan, B of A Merrill's chief executive, described the mortgage loan repurchase battle in November as "day-to-day, hand-to-hand combat."
He had preferred the harder route, arguing the company had the resources to handle it. "This really gets down to a loan-by-loan determination and we have, we believe, the resources to deploy against that kind of a review," he told analysts on the company's third-quarter earnings call.
But the decision does not guarantee a win for MBIA or plaintiffs like it in other cases. Statistical sampling is still no easy process, and the broad applicability of the judge's reasoning in the case isn't a certainty.
For large entities pursuing "blue sky" cases, in which an investor demands to rescind the sale of securities based on misrepresentations about the aggregate collateral at the time of purchase, the issue of sampling is not overly relevant, said David Grais of Grais & Ellsworth, who represents several Federal Home Loan banks and other clients pursuing such claims.
But for investors seeking to hold issuers responsible for losses on specific securities, sampling may be a vital tool.
"If you're trying to put back 100 loans, sampling doesn't make a big difference," Grais said. "But if you're trying to put back 100,000 loans, it does make a big difference."
It may be all the more essential in cases such as MBIA's New York suit against Countrywide, which focuses on a pool of smaller dollar second liens, he said.
"In a first lien case, one can imagine a scenario in which no sampling was available and it was cost effective to examine every loan. But this was really a necessary victory in a second lien case."
Though the influence of the New York court's decision should not be overstated. Grais said it was still good news for investors.
"I would say that it would be an intellectual influence rather than a binding precedent," he said.
A Bank of America spokesman emphasized the limitations of the ruling.
"We view the ruling really as a procedural decision," said Jerome Dubrowski, a spokesman for the bank. "The contracts at issue require MBIA to prove its case on a loan by loan basis. Nothing about the ruling prevents us from continuing to advance that position."
Events are moving quickly.
On Tuesday, Bank of America agreed to pay $2.8 billion to Fannie Mae and Freddie Mac to settle another case of disputed mortgage loans.
How much exposure B of A erased as a result of that agreement hasn't been disclosed, but the settlement indicates the bank is willing to take steps to move on from the issue rather than contest it in court.
MBIA is battling loan originators in 10 other lawsuits. MBIA believes that in some cases, more than 90% of the loan files contain breaches of contract. These include unreasonably stated income or lack of income verification, and debt-to-income ratios that exceed guidelines.