A new report discusses steps mortgage bankers can take to defend themselves against mortgage litigation.

A significant share of mortgage lawsuits focus on accounting estimates, according to the report authored by Anthony M. Lendez, a certified public accountant and partner at BDO Consulting. BDO provides expert and consulting services, including financial accounting and forensic analyses, to assess the risks facing investors and institutions relating to subprime lending activities.

Among targeted areas are allowances for loan losses, valuation of mortgage servicing rights and residual securities, and liabilities for loan repurchases, Lendez wrote. How defendants arrived at their estimates will determine how they should defend themselves.

The first line of defense for lenders is to demonstrate that they used good faith efforts to establish those estimates based on information available at the time they were made.

Lenders who underwrote loans to hold as investments would need to establish an allowance for estimated credit losses inherent in their loan portfolio at the balance sheet date, the report said. This would involve an analysis of the credit characteristics and performance of current portfolio loans. It would also take into consideration the values of properties securing the loans as well as general economic conditions.

"The allowance for loan losses should be linked to a periodic analysis of probable losses inherent in the loan portfolio," Lendez stated. "Mortgage lenders would need to show through internal documentation that appropriate methodologies and reasonable assumptions were used to arrive at the allowance. The assumptions need to be supported by objective internal and external sources."

But loans that are originated for securitization or sale in the secondary market need to account for the assets and liabilities resulting from those type transactions. Among liabilities would be losses from potential repurchases of defective mortgages or loans with early payment defaults.

Repurchase liabilities could be estimated based on a periodic analysis of their historical loan repurchase experience adjusted for current trends.

"If lenders used historical experience to estimate their allowance for repurchase losses, they would need to demonstrate how the historical information was adjusted for current trends," Lendez said. "For example, if the lender's average historical repurchase losses for the past five years were used to arrive at an estimate of the repurchase obligation but the trend in the past two years is more indicative of what is occurring with the loans that were originated by the lender, management would need to show how it weighed the most current data more heavily in determining its estimate of the allowance."