Investors pursuing claims against US banks for losses on pre-crisis RMBS believe recent developments in the Lehman Brothers bankruptcy case have bolstered their ability to get substantially higher payouts versus previous settlements.

Trustees of the Lehman RMBS bonds - US Bank, Law Debenture, Wilmington Trust and Deutsche Bank National Trust Company - proposed to hike the reserves for claims to US$12.143bn from US$5bn on August 22, according to a court filing. A hearing for the motion is scheduled for December 10.

The bonds have rallied on the back of that amid hopes that investors could net triple the amount received from prior settlements of soured mortgage bonds over the past three years issued by Countrywide, JP Morgan and Citi.

"People finally are paying for the option," said one hedge fund investor.

The move by the trustees is seen as more aggressive by market players and has drawn criticism by lawyers acting for Lehman who say the higher estimates are too out of line with settlements agreed before in the other cases.

"By suggesting that the RMBS claims should be valued at US$12.143bn, the RMBS trustees would have the Court believe that they accepted settlements with other banks that are five to six times less than the value of their actual claims," Lehman's lawyers, Willkie Farr & Gallagher and Jones & Keller, said in a filing on October 15.

Still, the situation is garnering plenty of attention as it could have broader ramifications if the trustees' claims are upheld.

Some disgruntled investors have already had luck in getting more cash out of banks following settlements they thought were too low, and this may give others more confidence to pursue cases.

Bank of America Merrill Lynch settled with American International Group (AIG) for an undisclosed amount on its representations and warranties claims on July 16, after the insurer argued that Bank of New York Mellon, the trustee acting on its behalf, should have secured a higher payout in the US$8.5bn settlement for Countrywide.

AIG's claimed that the potential settlement amount was as high as US$30bn at one point.

Investors involved in JP Morgan's settlement may be next to test the waters following the passing of the deadline on Monday for them to pursue claims. Some of the objectors so far are the Triaxx CDOs, the Federal Home Bank of Boston, NCUA, Ambac and QVT, according to market participants following the case. Those objectors will present their case to the judge tentatively scheduled for December 16.

ON THE HOOK

The Lehman case involves five bond shelves - SASCO, SAIL, SARM, LXS, and LMT - which all closed between 2004 to 2007 before the bank's bankruptcy.

The big difference between the Lehman situation and those of its predecessors is that the bond trustees this time around would be liable for any potential claims from investors. If the investors deem their payouts should have been higher, the trustees could be on the hook for the difference, according to Isaac Gradman, attorney at Perry Johnson Anderson Miller & Moskowitz LLP.

In contrast, banks gave indemnity to the trustees in the three earlier situations so that any future liability would be borne by the banks themselves.

Gradman estimated that the payout sought from Lehman equates to about 30 to 40 cents on the dollar of losses if the full US$12.143bn requested by the RMBS trustees is factored in.

That's as much as five times the six to eight cents on the dollar that was offered in the Countrywide settlement back in 2011, JP Morgan's in 2013 or the US$1.125bn Citigroup settlement in early 2014.

Lehman is standing its ground on its US$5bn offer.

In an objection filed on October 15, the bankrupt entity's lawyers said the Lehman settlement should be closer to US$1.96bn-US$2.44bn if trustees applied the same percentage on previous cases to the current Lehman Brothers situation.

The trustees however, believe that losses are being severely underestimated given the poor quality of the underlying loans of the securities and the misrepresentation of risk by banks when they were sold.

Their views are partly based on the analysis of Charles Parekh, director at Duff & Phelps. On August 21, Parekh estimated that the Lehman trusts had already suffered losses of US$15.68bn, with a further US$5.548bn of expected additional losses yet to come.

Parekh sampled 416,091 loans in 255 trusts, stating that it was not economically viable to analyse the complete pool given the cost and time it would involve. He was hired by law firms Alston & Bird, Seward & Kissel, Chapman & Cutler and Nixon & Peabody, counsel for the trustees.