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More questions around Bank of America's mortgage reserves

February 26, 2013: 9:01 AM ET

A prominent bank analyst says Bank of America is relying on a consultant's flawed analysis to hide the potential of bigger losses.

bank_of_america_ny.jc.homeFORTUNE - Bank of America still may not be ready to confess.

Last month, I wrote how a pair mortgage settlements reached in early January cost BofA (BAC) $5.3 billion more than it had previous indicated they would. For one of the settlements, with government controlled mortgage guarantor Fannie Mae, BofA had told investors that there was a chance the deal could cost the bank as much as $1 billion more than it was estimating. In fact, the final bill was three times that.

Now a prominent bank analyst is saying BofA is low-balling once again.

On Monday, Credit Agricole's Mike Mayo put out a report questioning whether BofA has put enough aside to cover the cost of settling $108 billion in investors losses on bonds related to Countrywide, the deeply troubled mortgage broker that BofA bought in 2008. BofA says $8.5 billion will do it. Mayo, based on the analysis of some mortgage and account experts, says it will cost more like $30 billion.

MORE: Bank of America's profits dinged by mortgage charges

The rub: Mayo says the consultant hired by BofA to come up with the loss estimate appears to have used a faulty methodology. What's more, the consultant, Brian Lin, used to work for Merrill Lynch, which was acquired by Bank of America at the height of the financial crisis. So he may be conflicted.

Also, Mayo says Lin's current firm, RRMS, is comprised of four people who lack impressive credentials and expensive office space. "It's in a part of town where, pre-Guiliani, [you] would certainly not go at night, and maybe be even a little careful during the day," Mayo told clients on a conference call last week. "They have four professionals at the firm, and I was kind of shocked. I mean these are the experts they relied on."

BofA spokesman Jerry Dubrowski says the bank believes it has "appropriately reserved for the exposures" BofA faces. He says accounting rules force the bank to only include losses that are probable, even if it's possible the bank could lose more. What's more, he said the Mayo analysis includes rulings in other court cases that might not apply to this case. "We believe extrapolating selective rulings from other venues involving other litigants and facts, and drawing conclusions about our settlements and other litigation matters does not portray a fair and accurate presentation of our litigation matters," Dubrowski says.

Ann Rutledge, who is a widely known expert on valuing mortgage bonds, says she has never heard of Lin, but says his background in the mortgage finance business seems to suggest he would be capable of estimating investor losses.

MORE: Why some homeowners are turning down free money

The issue dates back to a settlement BofA reached with a group of mortgage investors back in mid-2011, which was led by Bank of New York-Mellon (BK). A number of other investors claimed the deal was too low. A judge who has to sign off on the settlement has yet to rule.

BofA countered that the deal was based on the work of independent mortgage consultant Lin. But last week, on Mayo's conference call, Isaac Gradman, a lawyer who specializes in mortgage cases, called Lin's work flawed. First of all, Lin only considered $76 billion of losses, instead the $108 billion total. It isn't clear why. Second, Lin, according to Gradman, didn't examine any loans. Instead, he calculated his figure based on BofA's past settlements. But those settlements were on prime mortgages. The $8.5 billion settlement, though, related to mostly to subprime or alt-A loans, which generally had more documentation problems than prime mortgages.

Lastly, Lin appears to have gone with the belief that investors would have to prove in court that Countrywide's misrepresentations to investors - that, for example, a home was owner-occupied when it wasn't or didn't have a second mortgage when it did - actually led to the loan defaults. Recently, though, according to Gradman, a number of judges including U.S. District judge Jed Rakoff in New York, have ruled that investors don't have to connect the misstatements to missed payments. The misrepresentations on their own are enough for investors to demand their money back.

MORE: How banks could get blown away by the bond bubble

Add it all up, and Gradman says BofA could be forced to pay as much as $30 billion if the current settlement is scuttled, a lot more than the $8.5 billion BofA currently has set aside.

That said, Mayo's harping on consultant RRMS's office space is a little silly. Just because Lin's firm doesn't spend a lot on rent doesn't mean it's not credible. Lin and his partners could just be thrifty, and not out to impress visitors. Or they could be a bucket shop doing their ex-colleagues a favor that BofA is trying to pass off as credible. But you can't tell that by office space.

In the end, it's probably impossible, even for BofA, to know what a final payout will be. But what should really make investors leery, though, is that BofA's actions up to this point are only adding to the murkiness.

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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