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Mortgage-Bond Math Means Everyone Is a Winner: Jonathan Weil

There’s no reason to think MBIA Inc. and Bank of America Corp. are conspiring to make the Big Four accounting firm PricewaterhouseCoopers LLP look foolish. They couldn’t have done a better job, though, if they tried.

As the outside auditor for both companies, it’s PwC’s job to make sure each presents its financial results fairly. The strange part here is that MBIA and Bank of America have taken dueling accounting positions when it comes to some soured mortgage bonds that MBIA insured during the housing boom. PwC meanwhile is letting both companies’ approaches stand.

MBIA has recorded a sizeable asset on its balance sheet based on refund demands it has made to the bank. Bank of America, though, hasn’t booked any liability for those same claims. Common sense tells you one of them, and maybe both, will be proven wrong in the end. The companies, of course, say they are following generally accepted accounting principles.

While this may be an extreme example, it’s probably not unique. As the largest U.S. banks face increasing claims from mortgage investors and bond insurers, they also must decide how to quantify the potential costs on their balance sheets.

Likewise, the companies making the refund demands in some cases are recording accounting benefits -- sometimes as assets, other times as reductions to liabilities -- to reflect the value of their potential recoveries. Where it gets tricky is when both sides of the same claim reach opposing conclusions. That PwC is the auditor for both MBIA and Bank of America is an added twist.

MBIA’s Latest

Check the disclosures in MBIA’s latest quarterly report, and you’ll see a $2.2 billion accounting benefit called “estimated recoveries” that the Armonk, New York, bond insurer recorded on its Sept. 30 balance sheet. This represents the value of what MBIA says it’s contractually entitled to collect from various lenders as a result of ineligible mortgages that were included in the loan pools backing certain securities.

MBIA wants the lenders to buy back or replace those loans, on the grounds that they didn’t comply with the representations and warranties the banks made in their securitization documents. MBIA won’t say how much it’s owed by each of the banks. Nonetheless it’s easy to deduce from its disclosures that most of the estimated recoveries relate to loans originated by Countrywide Financial, which Bank of America bought in 2008.

MBIA’s claims also are the subject of a lawsuit the company has filed against Bank of America in a New York state court, one of several such suits the company is waging against different banks. MBIA says its $2.2 billion figure includes only what the company is owed contractually, not additional damages that might be awarded in litigation.

Now We Know

Bank of America, on the other hand, hasn’t recorded any liability for MBIA’s demands. Its reserves for repurchase claims were $4.4 billion as of Sept. 30. However, the company says it hasn’t established any liability for claims by bond insurers that are suing the bank; that’s how we know the liability it recorded for MBIA’s claims is zero. Bank of America says such litigation interferes with its ability to resolve bond insurers’ claims, and makes it impossible to reasonably estimate what its future repurchase obligations for them might be.

I won’t try to guess who is right here. Maybe Bank of America is being too aggressive by not recording any liability for MBIA. Perhaps MBIA’s recovery estimate is too high. Or maybe both companies’ numbers will prove too rosy.

One possible explanation for how this situation arose may be that the companies are relying on different accounting standards for their respective conclusions.

Different Strokes

A Bank of America spokesman, Jerry Dubrowski, said the company is treating claims by bond-insurer litigants as contingencies, which have their own set of rules. MBIA’s chief financial officer, Chuck Chaplin, said his company’s analysis falls under the Financial Accounting Standards Board’s special rules for financial-guarantee insurers. Conceivably the two accounting regimes might yield different financial-reporting results for the same transaction, depending on which side a company is on.

Steven Silber, a PwC spokesman, declined to comment.

A similar situation may be brewing at Assured Guaranty Ltd., which also is audited by PwC. The Hamilton, Bermuda-based bond insurer said it had recorded $1.4 billion of accounting benefits for its repurchase claims as of Sept. 30. A company spokeswoman, Ashweeta Durani, said more than half of that amount was related to Bank of America.

Unlike MBIA, Assured hasn’t sued Bank of America, which leaves open the possibility that the lender may have recorded a liability on its balance sheet for Assured’s claims. Dubrowski declined to say how much, if any, of Bank of America’s $4.4 billion reserve is tied to Assured. My guess is it’s probably less than what Assured has booked as a benefit.

It’s no surprise that two companies on opposing sides of the same claim would disagree about how much it is worth. Still, the job of an independent auditor should be to ensure that the numbers make sense.

At MBIA and Bank of America, they don’t. Investors can only hope that the left hand at PwC will look into what the right hand is blessing.

(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

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