BofA Prepares for Court, but Investors Aren’t Scared

Bank of America

After a nearly one-month hiatus, Bank of America’s (NYSE:BAC) Article 77 hearing over whether its $8.5 million mortgage-backed securities settlement will be upheld resumed on Monday. Investors reacted positively to the news that the case was once again moving forward.

Resolving Bank of America’s settlement dispute with American International Group (NYSE:AIG) is a key step in Chief Executive Officer Brian Moynihan’s efforts to clear up the bank’s liabilities, which are linked to the purchase of Countrywide Financial, an acquisition that significantly hurt the bank’s finances. Following news that the hearing would resume, investors bid the bank’s shares up as much as 1.84 percent.

In 2011, the lender agreed to a $8.5 million deal that it hoped would put to rest claims made by a group of mortgage-bond investors — a group that included AIG — that Countrywide had misrepresented mortgages underlying its securities. But the fairness of that settlement has since been called into question by AIG and the Federal Home Loan Banks of Boston, Chicago, and Indianapolis.

Already, Bank of America has spent more than $45 billion in legal expenses linked to its 2008 purchase of Countrywide Financial, which issued the soured mortgage-backed securities, and so far the company has rejected a bid to reopen negotiations into the proposed settlement.

Even before the bank’s $4.1 billion purchase of home-loan issuer Countrywide Financial was completed in July 2008, there were signs of trouble. That March, the Federal Bureau of Investigation revealed it would launch a probe into Countrywide for possible fraud relating to home loans and mortgages, problems that eventually caused the decline of securities backed by subprime mortgages and subsequently the collapse of several major financial institutions.

The institution’s practice of steering minority borrowers into higher-interest-rate subprime loans resulted in a $335-million settlement with the Justice Department. Legal troubles stemming from the acquisition of Countrywide as well as from Merrill Lynch resulted in numerous lawsuits for Bank of America, depressing earnings for many quarters and lowering the company’s stock price. In September 2008, shares of the bank traded above $30, but on Friday closed at just $13.06.

Bank of America’s decision to refuse negotiating the settlement suggests that the company’s management expects the New York judge presiding over the case to approve the deal. In early June, a court filing made by AIG showed that the bank had turned down its request for a renegotiation, after New York state Judge Barbara Kapnick suggested mediation as a way to solve the long-running dispute.

AIG has argued that Kapnick should not approve the deal because the sum is inadequate and the settlement was negotiated without the investors. In fact, in a court document, AIG alleged that it is a “pennies-on-the-dollar bargain” for Bank of America because the losses that resulted from the securitization of the loans in question have been valued at approximately $105 billion.

Daniel Reilly, a lawyer for AIG, asked the court to consider why the settlement amount cratered from the $50 billion investors initially requested to just $8.5 billion. Reilly, who said the proceedings represented the last phase of the 2008 financial crisis, told Kapnick that she was “making a determination as to whether the banks are winners or the investors are.”

In his opening statements, Derek Loeser, a lawyer representing the Federal Home Loan Banks of Boston, Chicago, and Indianapolis, argued that the smaller sum did not adequately compensate for the harm the soured mortgage-backed securities caused. “The liability is so huge that it was one of the factors that brought down the economy,” Loeser said, Reuters reported.

If the settlement is rejected, Bank of America will have to negotiate a more expensive agreement with the investor group or settle with individual bondholders, a method that could “drag out the process for years,” Morgan Stanley analyst Betsy Graseck wrote in an April 23 research note.

But if it is accepted, one of the biggest uncertainties tied to the bank’s takeover of Countrywide will be resolved. Already, the company agreed to an $11.7 billion settlement with the mortgage-finance institution Fannie Mae (FNMA.PK) in January. The bank has also ended disputes with bond insurers, including MBIA (NYSE:MBI), which settled for $1.7 billion in May.

All that remains are claims from private investors and the 2011 accord deals that were made with most of them, according to CreditSights senior banking analyst Pri de Silva. In total, Moynihan has spent more than $45 billion to clean up the inherited mortgage mess, which stemmed from $424 billion worth of troubled Countrywide home loans.

Follow Meghan on Twitter @MFoley_WSCS

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