Is Bank of America Corp (BAC) Under-Reserved?

The second problem with Mehta and Mayo’s rationale concerns their fixation on the methodology used by the Bank of New York Mellon’s experts to arrive at the $8.5 billion figure. According to an account of Mayo’s report, the consultant “appears to have used a faulty methodology,” may have been conflicted due to previous work at Merrill Lynch, and that his firm “is comprised of four people who lack impressive credentials and expensive office space.” While all of these may be legitimate concerns, absent the observation about the cost of the firm’s office space, they’re nevertheless peripheral issues.

The central question in the BONY settlement legal challenge, which is predicated on trust law, isn’t whether or not the settlement is fair per se. The issue is rather whether or not Bank of New York Mellon, acting in its capacity as the trustee for roughly 500 mortgage-backed securities, erred in the exercise in its discretion when entering into the $8.5 billion agreement. Again, while this may appear to be merely semantic, it’s fundamental, as Reuter’s Alison Frankel explains (emphasis added):

Under trust law, the bar for blocking a decision by the trustee is incredibly high. Anyone with an interest in the trust has a right to challenge the trustee’s decision. But unless objectors can show that the trustee, in this case BoNY, abused its discretion, acted unreasonably, or otherwise breached its fiduciary duty to the trusts’ beneficiaries, the court is not supposed to interfere with the trustee’s power.

This puts the challengers of the settlement at an incredible disadvantage vis-a-vis B of A. Does it mean they will lose? Not necessarily. But it does mean that the odds are stacked in B of A’s favor. Thus, to get back to Mehta and Mayo’s arguments, this legal reality lends further credibility to B of A’s reliance on the BONY settlement to calibrate its reserves.

The Foolish bottom line
At the end of the day, as I discussed at length in this series on B of A’s legal liability, there’s no question that the bank faces many billions of dollars in additional exposure for the sins of Countrywide Financial — I estimate the figure at between $15 billion and $25 billion in excess of allocated reserves. And there’s also no question that a rejection of the BONY settlement could dramatically add to this range. But that’s a far cry from saying B of A is under-reserved, and both Mehta and Mayo should know better than to make that mistake.

The article Is Bank of America Under-Reserved? originally appeared on Fool.com and is written by John Maxfield.

John Maxfield owns shares of Bank of America. The Motley Fool recommends BlackRock. The Motley Fool owns shares of Bank of America.

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