Bank of America Corp (BAC) Could Go Higher

Yesterday, shareholders of Bank of America Corp (NYSE:BAC) got news they’ve been waiting for: the nation’s second-largest bank by assets had finally settled its ongoing lawsuit with mortgage bond insurer MBIA Inc. (NYSE:MBI).

To the untrained eye, MBIA’s case against Bank of America Corp (NYSE:BAC) was the least of the latter’s concerns. Since the financial crisis, the bank has paid out more than $40 billion to settle claims related to its — or, rather, Countrywide Financial’s — sale of mortgage-backed securities to institutional investors leading up to the financial crisis. Its single biggest settlement, announced at the beginning of this year, added up to more than $10 billion. By comparison, MBIA was seeking a comparatively reasonable $3 billion to $4 billion in damages.

But the particularly contentious litigation had assumed a significance that far outpaced this range of liability. It’s no exaggeration to say that MBIA’s very existence turned on a favorable resolution. In a strange twist of fate, the company was on the hook for billions of dollars in insurance payouts to Merrill Lynch, which purchased the protection prior to its own acquisition by Bank of America Corp (NYSE:BAC). Had it been obligated to make the payments and thereby deplete its capital base, it was widely assumed that seizure by government regulators would follow soon thereafter.

The settlement, however, throws MBIA a lifeline. In addition to the $1.6 billion in cash that Bank of America Corp (NYSE:BAC) will pay to the insurance company, the bank has also agreed to release MBIA Inc. (NYSE:MBI) from its obligations to Merrill Lynch, provide a $500 million line of credit, and to relinquish MBIA bonds that it had acquired as a bargaining chip during the battle. In exchange, Bank of America received warrants to purchase 4.9% of MBIA’s common stock, which, if exercised, would provide additional capital for the latter.

The news was also good for Bank of America Corp (NYSE:BAC), as evidenced by its stock climb yesterday and today. Numerous legal issues in the dispute had recently been decided against the bank, and confirmation of those on appeal could have jeopardized other ongoing cases — most notably an $8.5 billion settlement that’s currently being litigated before a different judge in the very same court. While it’s impossible to say whether or not fears of contagion were well-founded, the risk was simply too large. As my colleague Amanda Alix discussed, estimates of the damages if the settlement falls through range as high as $60 billion.