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In what's turning into quite the financial-industry showdown, Bank of America (NYSE: BAC ) filed suit against MBIA (NYSE: MBI ) , asserting that the insurer should be forced to invalidate the debt amendments it made in November.
MBIA had been on the verge of running afoul of covenants on its debt, a transgression that would have left it in default and likely led to regulators marching in and taking control of its struggling mortgage-bond insurance unit. Through some quick maneuvering that included cutting side deals to buy back some of its debt, MBIA managed to push through changes to those covenants that should keep the subsidiary out of regulatory clutches.
Bank of America, meanwhile, was campaigning against those covenant changes and had even offered to buy up a bunch of MBIA's debt to help its cause. Why does B of A care so much? Because it believes that MBIA owes it insurance-policy payouts for soured structured-debt instruments (via Merrill Lynch). Should MBIA's structured-products insurance arm end up in the hands of regulators, that would make payment on those settlements more likely. Or so the theory goes.
In the wake of MBIA's smooth moves, B of A is arguing in this new lawsuit that the covenant-switcharoo wasn't kosher and should be reversed.
Of course, B of A isn't the only party here that thinks its owed something. For its part, MBIA has said that the banking giant (via Countrywide) is the one that owes it money for having the insurer back -- as an MBIA spokesman put it -- "fraudulent and misrepresented mortgage loans."
The slap-fight between the two financial giants might be humorous if the stakes weren't so high. MBIA is on the hook for settlements in the billions, while it claims that Bank of America owes it a whopping $4.5 billion.
Who wins here? Well, the lawyers. Isn't that obvious?
As far as who comes out on top between the two companies, it's hard to really think either one of the combatants is a shoo-in to win. Countrywide did indeed underwrite and sell some absolute schlock prior to the financial crisis. But it's hard to feel too badly for MBIA considering that it basically stopped doing diligence on the mortgage bonds it was insuring. In other words, dunce caps are due for both sides.
In the end, it seems reasonable to assume that the two sides will come to some sort of settlement that leads to payouts much smaller than the numbers currently being bandied about. Of course, if there is a winner-take-all scenario, only one of the two fighters here can handle such a haymaker. While a multi-billion-dollar settlement would certainly be painful for B of A, it's no stranger to billions in legal costs and has a hefty reserve on its balance sheet already. MBIA's bond-insurance department, on the other hand... we could say it's got a bit of a glass jaw.
Legal settlements are only one of the many risks facing Bank of America right now. To find out whether those risks should keep you from buying B of A's stock, check out The Fool's in-depth company report on Bank of America. The report details Bank of America's risk, prospects, and management and includes three reasons to buy and three reasons to sell. Just click here to get access.