Providing a major relief to Bank of America Corporation (BAC), a U.S. Appeals Court has ruled that BofA’s $8.5 billion settlement deal related to mortgage backed securities (MBS) will be reviewed in the New York state court, instead of the federal court. This ruling overturns a decision by the U.S District Court to take the case to federal court in October 2011.

The ruling for the settlement deal came after The Bank of New York Mellon Corporation (BK), the trustee for the MBS and the other parties – Pacific Investment Management Co. (PIMCO) and BlackRock Inc. (BLK) – argued that the settlement should remain in the state court, where the deal was actually filed. However, for the Walnut Place group, which was trying to move the case to the federal court, this is a huge setback.

What Does This Mean?

BofA stands to gain from the present ruling. The company prefers state court more than the federal court as the settlement was structured under the provisions of New York state law that calls for faster settlement proceedings.

Moreover, the provision under which the deal was filed does not allow the investors to opt out of the case and limit the objections, which were raised against BofA regarding the settlement deal. Further, the current ruling also provides BNY Mellon’s broad discretion in matters related to the agreements with investors.

The Back-Story

In June 2011, BofA had reached an agreement to pay $8.5 billion for its legacy Countrywide Financial Corp. mortgage repurchase and servicing claims. The settlement was for a group of 22 investors who suffered significant losses for their investments in MBS that were sold by Countrywide prior to the housing market failure. BofA had acquired Countrywide in 2008.

The agreement basically covered most of BofA’s legacy Countrywide- issued first-lien MBS repurchase exposure. It represented 530 trusts with original principal balance of $424 billion and total current unpaid principal balance of about $221 billion.

The group of investors, including BlackRock, PIMCO and the Federal Reserve Bank of New York had alleged that prior to the financial crisis, Countrywide had sold securities that were tied to bad-quality loans. The loans were not even managed well and lacked proper paperwork. Therefore, these investors sought a buyback relief in MBS that were offloaded by Countrywide.

However, the deal is yet to receive an approval of the court. But, some of the investors alleged that BofA had secretly reached a bigger settlement deal with the large institutional investors, leaving the smaller investors with losses. Hence, they sought the deal to be heard in the federal court. They further argued that the settlement amount was too low.

In Conclusion

The acquisition of Countrywide substantially increased BofA’s mortgage exposure compared with its peers. Following the collapse of the housing market, mortgage repurchases claim risk for the company grew manifold, a factor that has significantly drained the company’s bottom line over the last several quarters.

The settlement, if approved, will not impact BofA’s financials as the company has already bore the brunt of the deal in the second quarter of 2011 by taking the reserves for $8.5 billion. However, this will open the doors for similar investigations against many other big banks including JPMorgan Chase & Co. (JPM), Morgan Stanley (MS) and Wells Fargo & Co. (WFC) for their MBS tied to soured loans.

Shares of BofA currently have a Zacks #3 Rank, which translates into a short-term Hold rating.

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