Bank of America's Worst-Case Scenario Gets More Real (Update 1)

Bank of America story updated with details on mortgage servicing agreement in final paragraph.

NEW YORK (TheStreet) -- Bank of America (BAC) just saw the heat turned up again in its multipronged, multibillion-dollar legal battle over problem mortgages, according to an analyst report published Wednesday.

The latest trouble for the banking giant is a decision by MBIA (MBI) to "cross-appeal" a judge's ruling last month that was widely interpreted as being favorable to the bond insurer in its legal battle with Bank of America. MBIA filed its cross-appeal in New York State Supreme Court on Monday.

MBIA has accused Bank of America's Countrywide home loan unit of fraud and breach of contract related to 15 mortgage securities. On Jan. 3, New York State Supreme Court Justice Eileen Bransten ruled MBIA does not need to prove claims payments it has made on the securities were a direct result of the alleged misrepresentations.

Judge Bransten also ruled the insurer can seek damages against Bank of America if it can prove it there were misrepresentations by the bank and that MBIA would not have written the insurance if the misrepresentations had not been made.

Bank of America appealed the ruling on Jan. 25, arguing MBIA and Syncora (SYCRF.PK) (another bond insurer that filed a similar suit) should not be allowed to recover losses resulting from the insurance they extended, but should merely be allowed to tear up its insurance contracts if it wins the suit.

On Monday, however, MBIA filed its cross appeal because it had hoped Bransten would rule that [Bank of America] would have to repurchase all of the mortgages that contained misrepresentations, according to a report by Mark Palmer, analyst at BTIG. Palmer explains that Bransten made no such ruling because she believed "the language in the mortgage contracts was ambiguous."

MBIA's cross appeal is similar to one filed by Syncora on Jan. 5.

According to Palmer, the appeals by the bond insurers "put the worst-case scenario back on the table for [Bank of America]. If MBIA were to win on appeal, the ruling would apply not just to the bond insurers, but to mortgage-backed securities (MBS) investors as well. In such an event, [Bank of America's] exposure to mortgage put-backs could balloon."

Rather than see that happen, Palmer expects Bank of America to settle the case. Palmer and other analysts have estimated a settlement would cost Bank of America about $2 billion. Citigroup analyst Keith Horowitz has estimated Bank of America's ultimate legal tab related to problem mortgages from the housing boom will be $47, though perhaps as much as $67 billion in a worst case.

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