Bank of America's Reserves Face Fresh Skepticism

Lin declined to respond to Gradman, saying that his client, BNY Mellon, has asked him to leave the matter for the courts to decide. Spokesmen for Bank of America and BNY Mellon declined to comment.

In reaching his $8.5 billion number for the settlement, Gradman wanted to know why Lin started with $76 billion rather than the $108 billion worth of securities at issue in the lawsuit. He also argues Lin relied on a set of better-quality loans than he should have to figure out the likely loss rate that would be experienced by the $108 billion in securities at issue in this case.

Another important question raised by Gradman is whether the (MBS) investors had to prove their losses on the securities were the result of fraudulent or otherwise problematic mortgages by Countrywide Financial, which Bank of America acquired in 2008. Increasingly, judges have been determining that such proof is not necessary, says Gradman, citing a recent decision by U.S. Southern District of New York judge Jed Rakoff in a case involving Assured Guaranty (AGO)and Flagstar Bancorp (FBC).

"The Rakoff decision sort of, in my mind, puts the nail in the coffin in this issue," Gradman said.

Drawing on these and a couple of other arguments, Gradman and an accounting expert on the call, Bob Willens, concluded Bank of America needs to set aside another $16 to $22 billion in reserves against what could prove to be substantially more exposure to MBS liability.

Those additional mortgage putback reserves may not be enough if the $8.5 billion settlement is ultimately rejected by New York State Supreme Court Justice Barbara Kapnick, according to Gradman.

"If she rejects the settlement, then all bets are off. You have that 108 or now maybe higher number of losses in those pools, and you know, you would have various actions from different bondholders at that point, to recover their losses. And so it's anyone's guess as to what the amount of reserves that B of A would have to put up would be, but it certainly would be higher than eight cents on the dollar," Gradman said.

-- Written by Dan Freed in New York.

Follow @dan_freed

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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