Bank of America 'Worst Case' Could Worsen

NEW YORK (TheStreet) -- Bank of America(BAC) executives have spent a lot of time in the past few months talking about the numbers $7 billion to $10 billion in the context of the all-important question known as "mortgage putback risk."

Given the confusing array of mortgage-related risk around Bank of America, investors could be forgiven for thinking of $7 billion to $10 billion as a "worst case" number. It comes up often in Bank of America conference calls these days, as analysts try to answer the critical question of how much worse the bank's mortgage headaches could turn out to be.

Bank of America CEO Brian Moynihan

However, Bank of America's ongoing exposure could turn out to be far greater than that--a fact that was highlighted on the company's first quarter earnings call with analysts Friday.

First, a refresher on what mortgage putbacks--or repurchases-- are. The issue relates to mortgage loans that were pooled together and stuffed into bonds known as mortgage backed securities (MBS) ahead of the financial crisis.

The buyers of those MBS, mainly large institutional money managers like insurance companies and pension funds, have in many instances lost a great deal of money on their investments. Many of them are taking issue with the way those MBS were put together, arguing that the mortgages that were put into those MBS were fraudulent or in some way did not meet the criteria originally promised.

As a result, they have sicced their lawyers on the banks. While the exposure is expected to be costly for many large institutions, including JPMorgan Chase(JPM), Wells Fargo(WFC) and Citigroup(C), Bank of America(BAC) is widely thought to have the most risk, at least in terms of overall dollars.

The risk broadly falls into two buckets. One bucket is repurchases from government sponsored enterprises (GSEs) Fannie Mae (FNMA.OB), Freddie Mac(FMCC.OB), which guaranteed a big chunk of the MBS before the crisis, and today are virtually the only guarantors.

Bank of America announced a large settlement with Fannie and Freddie last quarter, which, while it led to a fourth quarter charge of $4 billion dollars, appeared to give investors some relief.

But anyone who thought that settlement took the GSEs out of the picture got an ugly surprise in this quarter: the Freddie Mac settlement encompasses existing and future claims, but the Fannie Mae settlement covers only existing claims.

What's more, the Freddie Mac settlement only covers mortgages underwritten by Countrywide, which Bank of America acquired in 2008. There are other mortgages underwritten by Bank of America that both GSEs are still trying to get Bank of America to buy back.