UPDATE 1-Court approves Bank of America's $8.5 bln mortgage settlement

NEW YORK, Jan 31 (Reuters) - A New York state judge on Friday approved most of Bank of America Corp's $8.5 billion settlement with investors in mortgage securities, which would resolve much of the bank's liability from its acquisition of Countrywide Financial Corp during the financial crisis.

Justice Barbara Kapnick ruled that Bank of New York Mellon , the trustee overseeing the securities, had acted reasonably in determining that a large part of the settlement was in the best interests of the investors.

Mark Zauderer, a lawyer who represents American International Group Inc, said the insurer plans to appeal aspects of the decision.

Kevin Heine, a spokesman for Bank of New York Mellon, declined to comment immediately after the ruling was made public.

Bank of America agreed to the settlement in June 2011 to resolve the claims of investors who had bought $174 billion of mortgage-backed securities issued by Countrywide. The investors said Countrywide misrepresented the quality of the underlying home mortgages, which went sour in the housing crisis.

Countrywide, based in Calabasas, California, was the biggest home mortgage lender in the United States until the housing market collapsed, specializing in so-called subprime loans, most of which it packaged into securities and resold to investors. It was bought by Bank of America in 2008.

A group of 22 investors supported the settlement, including institutions such as BlackRock Inc, MetLife Inc and Allianz SE's Pacific Investment Management Co.

But investors led by AIG objected, arguing that they were cut out of negotiations and that there was no evidence the settlement was adequate.

The objectors said Bank of New York Mellon was protecting its own interests in supporting the settlement and said that it got business from Bank of America. The objectors also criticized the trustee for failing to review loan files to identify defective loans in the securities.

In her ruling on Friday, Kapnick said the trustee had acted reasonably in reaching the settlement, with the exception of its agreement to settle claims related to mortgages that had been modified.

"This court finds that, except for the finding ... regarding the loan modification claims, the trustee did not abuse its discretion in entering into the settlement agreement and did not act in bad faith or outside the bounds of reasonable judgment," Kapnick wrote.

In a statement, Zauderer said AIG was pleased by the judge's exception for modified loans but disagreed with the other aspects of the ruling.

"This case is very far from over because the settlement will not take effect until many potential post-trial motions and appeals are resolved," Zauderer said in his statement.