There are two issues that investors will want to keep a particularly close eye on in these cases. First and foremost is the question of “successor liability.” This concerns whether B of A is even legally liable for Countrywide’s pre-2008 misdeeds. If a court holds that it’s not, then the bank could use the “nuclear option” of putting its Countrywide subsidiary into bankruptcy if damages become unmanageable. However, if a court holds that B of A is liable, then no such option exists, leaving the bank with significantly less leverage in settlement negotiations. Second, there’s the issue of “loss causation,” which concerns whether there must be a causal link between the monolines’ losses and Countrywide’s breach of contract.
Without wading into the details here, both issues are critical because they played central roles in B of A’s $8.5 billion settlement with The Bank of New York Mellon Corporation (NYSE:BK), which is coincidentally awaiting judicial approval from the same court.
What are the damages here?
Arriving at an estimate of how much B of A ultimately owes the monolines is easier said than done, as even the bank admitted in its most recently quarterly filing that it’s in the dark on this question:
It is not possible at this time to reasonably estimate probable future repurchase obligations with respect to those monolines with whom we have limited repurchase experience and, therefore, no representations and warranties liability has been recorded in connection with these monolines, other than a liability for repurchase claims where we have determined that there are valid loan defects and determined that there is a breach of a representation and warranty and that any other requirements for repurchase have been met.
What B of A is saying is that it can’t estimate the potential exposure from monoline claims and, as a result, the bank hasn’t fully provisioned for them. When settlements and/or judgments do come, the damages could hit B of A’s bottom line close to dollar for dollar.
To get back to the issue of damages, we can draw certain conclusions from the settlement B of A reached with Syncora Guarantee, one of the smaller monoline insurers, in the middle of last year. In exchange for a payment of $375 million, Syncora agreed to resolve claims stemming from 14 private-label MBSes with an original principal balance of a combined $17.3 billion and of which $4.4 billion had either defaulted or were severely delinquent as of June 30, 2012. If you break this down, B of A paid $0.085 for every dollar of toxic mortgages.
If you then apply this figure to the $52.6 billion of defaulted or severely delinquent mortgages sold to all monolines, you get an estimate of aggregate damages of around $4.5 billion for the class as a whole. This is notably less than half of the total damages the bank has paid out to the GSEs and will similarly amount to a fraction of its liability to private-label investors.
But a word of warning is appropriate here, as there are at least two problems with this estimate. The first is that the monolines which have settled thus far — Syncora and Assured Guaranty Ltd. (NYSE:AGO) — are by definition the most amenable to doing so. They’re also two of the smallest players in that space. Meanwhile, the litigation that remains in court is backed by both the largest and the most litigious of the bunch, including MBIA Inc. (NYSE:MBI), Ambac Assurance, and Financial Guaranty.