Wednesday, December 19, 2012

On MBIA's Motion For Summary Judgment on Breach of Insurance Agreement, Justice Bransten Has Nothing To Fear But Fear Itself

At the hearing before Justice Bransten last week on whether to grant MBIA summary judgment (SJ) on its claim that Bank of America (together with its affiliates, BAC) breached its insurance agreement with MBIA, BAC counsel had this to say:  "Now, the request by plaintiff here, your Honor, to award billions of dollars in damages in what amounts really to the word of one man sight unseen other than in the courtroom today whose testimony is flatly disputed by at least six Countrywide experts is remarkable, is extraordinary and I suggest to your Honor it is unprecedented."

Judges are institutionally reticent to find that there is no remaining issue of fact so as to authorize the grant of SJ, and BAC counsel led off its argument by seeking to stoke this reticence.  As well, "unprecedented" is not normally a part of a judge's comfort zone.  Whether or not this caused Justice Bransten any apprehension beyond normal judicial caution we will not know.  But if Justice Bransten thinks carefully about the nature of the evidence necessary to prove the breach of insurance agreement claim and reviews the actual evidence presented at the SJ hearing, then to paraphrase FDR, any fear Justice Bransten might have to award SJ to MBIA on the claim of breach of insurance agreement would be based only on fear itself.

It is important to keep in mind that with respect to MBIA's claim that BAC breached its insurance agreement, the facts necessary to prove this case are contained in boxes holding loan files...indeed, many boxes holding over 389,000 loan files.  This is entirely a documentary case, based on loan files that need to be inspected, and the results of this inspection that need to be analyzed and argued in terms of the representations and warranties (R/Ws) made about them in the insurance agreement. This is hardly a case that involves the "word of one man."
What needs to be done to prove or disprove a breach of R/Ws contained in the insurance agreement is to afford each side the opportunity to (i) inspect the loan files in the same statistically significant sample of loans selected from the insured securitizations, in effect conducting a re-underwriting of the loan files, (ii) issue a report based on its re-underwriting, and (iii) impeach the accuracy and validity of the other party's re-underwriting, if there is a material discrepancy between the results of each re-underwriting.  This has been done.  MBIA conducted its re-underwriting of the entire sample and issued its report (Butler report), whereas BAC declined to conduct a similar re-underwriting, but rather presented evidence in rebuttal of the Butler report.

Given that the R/Ws contained in the insurance agreement refer to matters relating to the mortgage loans that can be determined by means of a review of the documents contained in the loan files (as may be supplemented to the extent necessary by subpoenaed documentary information to verify matters such as borrower income), breach of insurance agreement R/Ws is not a claim where live witnesses are needed to present their recollection of events, the trier of fact should assess the live witnesses' demeanor or credibility, or the trier of fact is needed to determine whether some action was reasonable under the circumstances. 

The insurance agreement speaks for itself as a document to be interpreted as a matter of law.  Similarly, the results of the re-underwriting of the loan files by MBIA contained in the Butler report and BAC's rebuttal of the Butler report will determine whether the insurance agreement R/Ws have been breached, based on (i) the presence or absence of documents such as qualified appraisals, the mortgage note etc. in the loan files, and (ii) what those documents disclose on their face after inspection with respect to matters such as FICO score, combined loan to value ratio etc, as compared to the R/Ws made with respect to such matters.

As discussed below, for purposes of its SJ motion, MBIA is moving only on loans bearing defects that BAC's own executives have testified would adversely affect credit quality, and which BAC's own underwriting guidelines indicate are material (eg MBIA moved on SJ with respect to only incorrect FICO scores that caused the loan to be mispriced loan under BAC's pricing protocols, indicating materiality).

Of course, mistakes can be made in the re-underwriting process, but BAC has been afforded the opportunity to correct any mistakes made in the Butler report.  All of the loans have file numbers, they have been inspected, re-inspected, and any mistakes corrected.  There is no need for live witness testimony about the results of the re-underwriting, as once each party has had the opportunity to inspect the sample loan files and rebut the the results of the other party's re-underwriting, the results speak for themselves as competent testimony of each party.

Now after all this, if there is a material dispute between the results of the re-underwriting performed by BAC and MBIA, respectively, after eliminating any false discrepancies that Justice Bransten may determine to be irrelevant or improperly asserted as a matter of law, then there is a role for a trier of fact to sort through the re-underwriting dispute.

But, this is not the case with respect to MBIA's motion for SJ on breach of insurance agreement.  Indeed, after reviewing the results of the parties re-underwriting and reviewing the
disputes between these results, after eliminating those discrepancies that Justice Bransten is authorized to decide as a matter of law, and applying a materiality standard under New York insurance law that, while a mixed question of law and fact, is also susceptible of resolution on SJ, it is clear that MBIA is entitled to SJ on its claim of breach of insurance agreement. 

Thursday, December 13, 2012

Is Bank of America Too Big To Think?

We know that Bank of America (BAC) is Too Big To Fail (TBTF).  Is BAC also Too Big To Think (TBTT)?

BAC stated this evening that it purchased $136 million worth of MBIA 5.70% notes in the tender offer that it had extended without conditions, and that it had issued a notice of default to MBIA and the trustee for the notes. BAC said it issued the default notice because the adoption of a proposed amendment to remove the cross default provision to MBIA Insurance was in violation of the terms of the indenture. By owning at least 25% of the notes, BAC is entitled to send MBIA its own default notice rather than ask the trustee to do it under the indenture, although of course its ownership position doesn't somehow convert a claim that there is an event of default into an actual event of default.

I posted earlier  here that when BAC extended its tender offer without conditions, BAC might wish to pursue some litigation theory that required it to own notes, or it was rounding up MBIA wampum in anticipation of a possible settlement with MBIA. But if you take at face value that BAC just spent $136 million to buy MBIA notes at a 20% premium to pursue a doomed litigation and corporate strategy, then you definitely think that BAC is TBTT.

While I have not seen BAC's complaint, it is clear to me what BAC's litigation theory is.  BAC is certain to allege that the consents that noteholders issued to MBIA before selling their notes to MBIA are, in substance, consents expressed by MBIA, and MBIA cannot express a consent with respect to notes they have issued that they beneficially own.

Like all indentures, the MBIA 5.7% note indenture states that notes beneficially owned by MBIA and its affiliates are not "outstanding" for purposes of the indenture.  If they are not outstanding, no consent expressed with respect to such notes can be counted towards meeting the majority approval for an amendment.  In essence, an issuer can't oppress its noteholders by buying up notes and then forcing upon them a disadvantageous amendment by virtue of its noteholdings.  I am certain that BAC is alleging that by purchasing notes soon after noteholders expressed a consent to approve the change in the cross default provision, MBIA should be treated as having beneficially owned such notes at the time the consent was expressed, thereby invalidating the consent.

First off, this is a losing litigation strategy.  

These transactions can certainly be orchestrated to conform to these rules of beneficial ownership with respect to "outstanding" notes.  I expect  that MBIA was advised capably to structure the transactions so that MBIA did not acquire notes from consenting noteholders until after consents were expressed.  And while I was not there when MBIA orchestrated these consent-then-sale transactions to see if there were any winks or nods, neither was BAC.  Moreover, we are talking about institutional investors and debt securities, with respect to which an issuer owes the noteholder no fiduciary duty. So this is as close to the wild, wild west as you are likely to see in the securities markets. Whine and go home, and winks and nods, if any, be damned.

But, even if it was a winning litigation strategy, it is a losing corporate strategy.  

So what if BAC invalidates the amendment? The notes that MBIA bought still exist.  Remember that they constitute a majority of the 5.7% notes. Even if BAC wins in court MBIA can simply resell the notes to a friend of the family (maybe even at a discount, if it is a friendly friend), and the friend of the family noteholder can then promptly provide MBIA a new consent with respect to its majority of notes, and ...presto...the amendment has been re-approved.  What can BAC do about this?  It is the proud owner of a minority amount of, BAC can do nothing about this little fix-it maneuver, assuming that BAC could even win on the merits of its litigation theory (which I repeat is weak).

So, go big BAC, no guts no glory, go buy $136 million of notes to make a claim that you need only a single $1,000 note to make, and spend as much as you can knowing that you can't spend enough to own a blocking position to a new amendment once MBIA de-sterilizes the notes that it owns.  One might think there is some advantage to BAC under the indenture in buying 25% of the notes (approximately $$85 million), so that BAC can send an event of default notice to MBIA, rather than ask the trustee to do it, but (i) owning 25% of the notes does not, ipso facto, convert a claim that there is an event of default into proof of an actual event of default, as BAC must still prove its case, and (ii) why would BAC buy an additional $51 million of the notes beyond reaching the 25% threshold, even if it thought reaching the 25% threshold offered some advantage?

I prefer to think that BAC is really buying some MBIA wampum in preparation of an eventual settlement and just giving MBIA a little tsouris (heartache) in the process for good measure, because I don't think BAC is so stupid as to spend $136 million to pursue a doomed strategy.  But perhaps I am wrong and BAC is really TBTT.

NB:  this blog is not intended to be investment advice, and should not be relied upon by anyone to constitute investment advice.  Investing is a tough game, and everyone must do and "own" their own work, because you will certainly own your investments.

Disclosure: long MBI.  Follow me on twitter.

Friday, December 7, 2012

Is Bank of America Looking to Round Up Some MBIA Wampum?

Why did Bank of America (BAC) recently extend its tender offer for MBIA's 5.7% notes until 12/11, and eliminate the two conditions that would excuse BAC from purchasing notes after a successful note consent solicitation by MBIA?

These two conditions were "there having been validly tendered pursuant to the Tender Offer and not validly withdrawn, not less than a majority in aggregate principal amount of the [MBIA  5.7% Notes] outstanding,” and that “MBIA shall not have obtained the requisite consent of [noteholders] needed to validly approve the [amendments eliminating cross-default to the securitization insurance subsidiary (Securitization Sub), and those amendments] shall not have become effective."

One can understand that BAC might want to extend its tender offer if it had developed some litigation theory against MBIA which required that BAC maintain an open tender offer in order to pursue the claim.  I am not aware of what that theory might be, but it is a plausible explanation.  But BAC could have extended its tender offer for this purpose without removing these conditions.  Indeed, one would remove these conditions only if one wanted to buy any and all tendered notes irrespective of the success of the MBIA note consent solicitation.

Now, BAC can always terminate the tender offer before 12/11 without any obligation to purchase notes, so BAC has not irrevocably committed itself to buying MBIA notes.  But still, one is left searching for a plausible reason why BAC would want to put itself in the position of being potentially obligated to buy MBIA notes after their cross-default provision to Securitization Sub has been eliminated. 

Mark Palmer at BTIG Research has provided us one such plausible reason.  In his latest research note on MBIA,, Palmer points out that when BAC settled with Syncora, BAC provided Syncora a mix of consideration, including cash and other assets, and securities of Syncora, ostensibly in order to confound anyone (such as other plaintiffs and potential plaintiffs in fraud actions against BAC) from being able to determine with certainty what was the precise aggregate consideration BAC paid Syncora in settlment of Syncora's fraud suit against BAC.

Palmer speculates that BAC might be similarly putting itself in a position to settle with MBIA with a similar mixed bag of consideration, consisting of cash, other assets (ostensibly, the commutation of BAC's cmbs cds), and MBIA securities.  Palmer says this:  "What does this [the mix of consideration in the Syncora settlement] have to do with BAC’s decision to push forward with its cash tender? We believe that by adding the 5.7% notes to its various other exposures to MBIA, BAC could at the time of a settlement with the bond insurer be able to similarly muddle the math done by those trying to figure out what portion of its exposure that it had paid out. The bank could thereby better position itself to minimize the amount it will pay out to the many other parties suing it over representation and warranty breaches."  As well, if BAC pays 95% in its tender offer and gets credit for 100% of the notes by MBIA, there is a 5% vig that BAC earns to boot.

Or, as Yogi Berra might put it in an insurance company television commercial, BAC may be beginning to load up on things that are not money but are as good as money to MBIA.  What I would call wampum...items having trading value to MBIA, but whose precise value will not necessarily be disclosed with itemized specificity in the public announcement of any settlement.  Indeed, just like all of the previous commutations of cmbs cds that MBIA executed with former co-plaintiffs with BAC in the Article 78, one would expect that any commutation of BAC's cmbs cds would not have a value assigned to it.

This is all speculation, of course, but it offers a plausible reason why BAC eliminated its two principal conditions to its tender offer when BAC extended it.  And this is the first plausible reason I have been able to come up...apart from the notion that BAC is just trying to mess with the heads of MBIA longs.

NB:  this blog is not intended to be investment advice, and should not be relied upon by anyone to constitute investment advice.  Investing is a tough game, and everyone must do and "own" their own work, because you will certainly own your investments.

Disclosure: long MBI.  Follow me on twitter.

Friday, November 30, 2012

Are Bank of America's CMBS CDS Insurance Policies?

I have posted about a scenario whereby MBIA could place MBIA Insurance (Securitization Sub) in a voluntary rehabilitation in order to adopt a "full litigation mode" strategy here.

In this "full litigation mode" strategy, Securitization Sub in rehabilitation would "turn the tables" on Bank of America (BAC) and pursue its fraud claims against BAC to the bitter end in order to maximize its damage recovery, and cram BAC's cmbs credit default swaps (cds, which BAC carries on its balance sheet at $1.35 billion) into a subordinated position, entitled to payment as a general unsecured claim only after payment has been made on National's $1.6 billion loan to Securitization Sub and all other payments have been made on insurance policies issued by Securitization Sub.

The distinction between an insurance policy and a cds for purposes of payment by an insurance company in rehabilitation is that the former is regulated by the New York Department of Financial Serves (NYDFS) and the latter is not.  For example, the form of an insurance policy must be filed and approved by NYDFS under NY Insurance Law Section 2307(b) and the form of a cds contract need not.  In MBIA's most recent investor conference call, MBIA CEO Brown confirmed that MBIA's exposure to BAC was in the form of "derivatives" as opposed to insurance policies.

The relevance of this distinction for purposes of payment of BAC's cds by Securtization Sub in rehabilitation is that the rehabilitator would classify BAC's cds as subordinated class 6 general unsecured claims, payable only after all insurance policy claims (more senior class 2 claims) and Natonal's secured loan have been paid.

The best authority for this proposition is the recent decision, In the Matter of the Rehabilitation of FRONTIER INSURANCE COMPANYIndex No. 97-06. (Supreme Court of New York, Albany County, May 23, 2012) (Judge Richard M. Platkin). (STATE OF NEW YORK SUPREME COURT COUNTY OF ALBANY

In Frontier Insurance, Judge Platkin held that surety bonds should be treated as "insurance policies" for purposes of classification as a class 2 claim. However, his reasoning makes clear that surety bonds are treated as "insurance policies" precisely because NYDFS exercises regulatory authority over them.  NYDFS exercises no regulatory authority over cds.  (See e.g. State of New York Insurance Department Will Not Regulate Credit

Using Frontier Insurance as a precedent, MBIA would be able to argue convincingly that since NYDFS does not exercise regulatory oversight over BAC's cds, it would be proper for Securitization Sub in rehabilitation to defer payment on BAC's cds in what amounts to a cramdown of BAC's claim.

What does this mean for purposes of settlement discussion between MBIA and BAC?  As a commercial mediator, I have found that one of the biggest barriers to consensual settlement is disparity of resources and negotiating leverage between the parties. Up to now, BAC has clearly maintained the upper hand in any settlement negotiation because of its superior resources.  It seems to me that now, MBIA has turned the tables on BAC.

Now that MBIA has amended its note indentures to prevent a cross-default to Securitization Sub's rehabilitation, and assuming MBIA wins the Article 78, MBIA is able to negotiate from a position of equal strength, by posing as a credible threat its own "full litigation mode" strategy, in which BAC's former strength, its willingness and ability to go the distance with litigation, is effectively turned by MBIA against BAC.

NB:  this blog is not intended to be investment advice, and should not be relied upon by anyone to constitute investment advice.  Investing is a tough game, and everyone must do and "own" their own work, because you will certainly own your investments.

Disclosure: long MBI.  Follow me on twitter.

Wednesday, November 28, 2012

How Does Your BATNA Look Now, Bank of America?

I have recently posted about a mediator's perspective of the MBIA v. Bank of America (BAC) litigation here, as well as a possible strategy for MBIA to "mail the keys" to MBIA Insurance (Securitization Sub) here.  It occurs to me that it might be best to consider these posts together in an analysis of how BAC might view the value provided it by a negotiated settlement agreement, as compared to what BAC might consider to be the value of its "best alternative to a negotiated agreement" (BATNA).

The term, BATNA, was first introduced in the seminal Fisher and Ury text, "Getting to Yes."  They posited that whenever parties in conflict seek to negotiate a settlement, they will compare the value and benefits provided to the party by the settlement (settlement value) to the maximum value and benefits that may be obtained by the party by pursuing some strategy other than settlement (the party's BATNA).  Typically in a litigation context, this would involve continuing the litigation through to court resolution, or pursuing settlement at a later time thought to be more propitious for the party.

In my last mediator's perspective post, I provided a framework by which I thought both MBIA and BAC could obtain from settlement what they needed, although not necessarily all that they wanted.  In that post, just to give some concreteness to the discussion, I assigned a notional value to BAC of this settlement at a negative (that is, a net payment to MBIA) $2 billion.

Assuming that this settlement value is correct for the sake of analysis, BAC would compare this settlement value to the value of BAC's BATNA.  It is not difficult to assess how BAC views its BATNA; BAC has pursued a litigation strategy of dragging the proceedings out and litigating every issue in an effort to wear down and impoverish MBIA, thereby using its superior resources to force MBIA to accept what MBIA would consider to be an "uneconomic" settlement.

If BAC were to prevail in the Article 78 proceeding, or if a rehabilitation or insolvency proceeding of Securitization Sub would create a cross-default to MBIA's public debt, BAC's litigation posture and its ability to pursue its BATNA would be substantially strengthened, and BAC's threat to continue the litigation would create significant pain for MBIA.  So one might consider that if these options remained available to BAC, BAC would value its BATNA as substantially greater than settlement value (ie a lesser net payment to MBIA than $2 billion). 

However, it appears that BAC will lose the Article 78 (though we must wait for Justice Kapnick's decision to be sure), and MBIA eliminated the cross-default scenario with its recently completed note consent solicitation.

Now, let's consider how BAC might view its BATNA's value if MBIA suggests in a settlement negotiation that MBIA is prepared to "mail the keyes" of Securitization Sub to the New York Department of Financial Services, as discussed in this post.

First, it is important to distinguish between NYDFS liquidation and rehabilitation proceedings. When I refer to the "mail the keys" strategy, I am referring to a voluntary rehabilitation proceeding initiated under Section 7402(l) of the NY Insurance Law.  In order to understand what a voluntary rehabilitation of Securitization Sub would look like, this FAQ site on FGIC's website is a good place to start.  Essentially, the rehabilitator (NYDFS or its designee) would come up with a rehabilitation plan for Securitization Sub, much like a debtor-in-possession federal bankruptcy proceeding.

The rehabilitator of Securitization Sub would be charged with maximizing MBIA's recoveries in its fraud damages suits against BAC and other mbs issuers, and would have the power to classify claims (such as BAC's cds) and provide for the timing and payment of these claims in a manner that is fair to those claimants and in the best interest for the rehabilitation of Securitization Sub. In other words, the rehabilitator could marshall Securitization Sub's assets and defer payment on its claims in a manner that will give Securitization Sub-in-rehabilitation the staying power to carry on MBIA's litigation against BAC as long as necessary.

It should be plain to see that this could quickly become the realization of BAC's biggest nightmare: a turning-around-of-the-litigation-tables in which the rehabilitator determines that it is in the best interest of the rehabilitation if Securitization Sub pursues MBIA's litigation straight through to final decision and appeal, and that all Securitization Sub claimants would have to await payment until these litigation proceeds are realized and the rehabilitated Securitization Sub is able to make equitable payment to all claimants (including repayment of MBIA's $1.6 billion secured loan to Securitization Sub).

Just consider what this should do to BAC's calculation of the value of its BATNA?  If I were BAC at a settlement negotiation with MBIA and I heard that MBIA was threatening to commence a voluntary rehabilitation proceeding, I would consider this to be a credible threat.  Indeed, one might think that BAC has shown us that it recognizes this as a credible threat by publicly stating that any successful consummation of the MBIA consent solicitation would make a rehabilitation proceeding of Securitization Sub "more likely".  

In any "full litigation mode" rehabilitation plan pursued by NYDFS, one might consider that BAC's BATNA should be valued much less than its settlement value (ie resulting in a much greater net payment to MBIA).  Moreoever, any "full litigation mode" rehabilitation plan would also expose BAC to further damaging legal precedents for its other existing and potential litigations (see here and here).

So, how does your BATNA look now, BAC?

NB:  this blog is not intended to be investment advice, and should not be relied upon by anyone to constitute investment advice.  Investing is a tough game, and everyone must do and "own" their own work, because you will certainly own your investments.

Disclosure: long MBI.  Follow me on twitter.

Monday, November 26, 2012

Thoughts About MBIA/BAC Post-Consent Solicitation

MBIA announced this morning that it had successfully completed its consent solicitation and that it had amended the indentures for all of its outstanding public debt, so that a rehabilitation proceeding involving MBIA Insurance (Securitization Sub) would not create a default under MBIA's public debt.

I have discussed a mail the keys to Securitization Sub scenario here, whereby MBIA can substantially improve its negotiating position, and substantially worsen Bank of America's (BAC) negotiating position, with regard to settling their fraud and Article 78 litigation by threatening to invite the New York Department of Financial Services (NYDFS) to take over Securitization Sub and place it into rehabilitation.

The only event that now needs to take place before MBIA can embark on the mail the keys scenario is for Justice Kapnick to render her decision in the Article 78 proceeding brought by BAC, and for that decision to be adverse to BAC.

Or does Justice Kapnick even have to announce her decision before MBIA mails the keys, after all?

Monday, November 19, 2012

A Mediator's Perspective on the MBIA v Bank of America Litigation---Part 3

I have discussed a mediator's perspective of settlement of the litigation between MBIA and Bank of America (with its affiliates, BAC) previously here and here. In this post, I want to consider a possible "mediator's move" that might break a possible logjam in the negotiation. (Of course, I have no "inside information" regarding the status of any settlement negotiations between MBIA and BAC, and the numbers I suggest below may be viewed by the parties as unacceptable.  However, I do believe that my mediator's view may have some applicability to establish the framework for any settlement negotiation of this litigation, and offer some insight into how a possible settlement might play out).

A "mediator's move" is an attempt by the mediator to reframe the settlement negotiation when discussion has solidified around party "positions" rather than "interests."

An interest is an objective to be achieved by the party in the negotiation. An interest can be achieved in many ways, and the art of mediation is to seek to promote each party's interest in a manner that infringes upon the other party's interest in the least possible manner.

A position is the particular proposal that the party adopts to achieve its interest.  When positions are denominated in dollars involving the payment by one party to another of a fixed amount, party offers and counteroffers typically involve a zero-sum game: each party's attempt to better its position by a dollar is viewed as an attempt to worsen the other party's position by a dollar.  It is hard to improve a party's dollar position without hurting the other party's dollar position.

When events giving rise to the controversy have all transpired and the parties are litigating over past actions and incurred damages, it can be difficult to achieve a mediator's move away from party positions denominated in dollars to party interests achieved in other ways.  But if part of the controversy revolves around future actions and contingencies, there may be an opening for a mediator's move that makes such contingency work in favor of settlement.  There may be such an opportunity in any settlement of MBIA v. BAC.

Thursday, November 15, 2012

Will MBIA Get Summary Judgment on Bank of America's Breach of Insurance Agreements?

While much of the focus concerning the litigation between MBIA v. Bank of America (with its affiliates, BAC) is currently diverted to the contest between MBIA's debt consent solicitation and BAC's debt tender offer, discussed here, the real drama to this David v. Goliath controversy is about to be played out in front of Justice Bransten on December 5, 2012.

At this hearing, MBIA will be seeking summary judgment that BAC breached its insurance agreements with MBIA, authorizing MBIA to obtain recissionary damages equal to all of the losses sustained by MBIA on its insured BAC mbs pools, plus interest at the statutory annual rate of 9%.  This amounts to approximately $5 billion in damages.

The debt consent solicitation/debt tender offer contest has many possible outcomes, but MBIA does possess a "checkmate" move at the end of the game.  The notes (2034 notes) that are the subject of the consent solicitation/tender offer contest are prepayable by MBIA at any time.  MBIA will need to make a private placement of at least $330 million of replacement notes (with registration rights) that have a cross-default provision to its liking in order to prepay the 2034 notes, and the prepayment will be costly to MBIA, but the point remains:  MBIA has a pathway to achieve what it wants, the elimination of all holding company debt that cross-defaults to its securitization insurance subsidiary debt.

So, now back to the litigation front.  It has not been easy to track the parties' arguments, both because of redactions within the briefing and seals of entire motion papers and exhibits, as well as the flurry of counsel activity as the motions for unsealing filings (argued today), primary liability (to be argued December 5, 2012) and successor liability (to be argued December 12, 2012) have approached. 

It makes sense, however, to focus on two motions for summary judgment in particular that are game-changers, possibly game-enders:  BAC's breach of insurance agreements (this post), and the BAC parent company liability for subsidiary Countrywide's liabilities (future post).

Tuesday, November 13, 2012

MBIA v Bank of America Litigation Goes Corporate (and Hostile)

Bank of America (BAC) has just launched a tender offer for approximately $329 million of MBIA notes due 2034.  The purpose of this solicitation is to frustrate MBIA's consent solicitation of holders of all public MBIA debt to amend their indentures to prevent a default by MBIA Insurance (Securitization Sub) from constituting a cross default under MBIA's public debt.

In other words, if MBIA is able to win the Article 78 proceeding (now sitting in Justice Kapnick's decisional lap for the past 5 months), MBIA could theoretically (and euphemistically) mail the keys to Securitiziation Sub to the New York Department of Financial Services (NYDFS).  NYDFS would put Securitiztion Sub in rehabilitation and likely (i) continue the fraud and putback litigation with respect to which MBIA is nearing trial against BAC, and (ii) create a payment plan outlining how claimants (such as BAC) would get paid as funds become available to Securitization Sub.  This "mail the keys" scenario creates substantial additional risk for BAC.

If MBIA were to do this after obtaining the necessary debt consents, MBIA, the holding company for Securitization Sub and National Finance (Public Finance Sub), would not be in default under its holding company debt and would continue to own and operate Public Finance Sub.  Financial commentators have stated that MBIA is worth over $20/share, taking into account only the value of Public Finance Sub.

This ability of MBIA to mail the Securitization Sub keys after a win in the Article 78 case would appear to be primarily a negotiating tactic.  MBIA would appear to be leaving meaningful value on the table at Securitization Sub by using this strategy, and it would still be at risk to receive back repayment of Public Finance Sub's secured $1.6 billion loan to Securitization Sub.  Of course, apart from MBIA's desires, the NYDFS could always come in and take over Securitization Sub under its insurance regulatory powers...although MBIA has stated in its most recent earnings call that MBIA's debt consent solicitation is not being undertaken in view of any sense that the NYDFS was about to do this.  So, in addition to negotiating tactics, MBIA is also seeking to preserve the company ex-Securitzation Sub in the event of an undesired NYDFS takeover by conducting its consent solicitation.

And so, BAC has replied with its own negotiating tactic, deciding to spend as much as $329 million (and at least $165 million to buy 50% of the notes under their early tender pricing) to deny MBIA from being able to employ its negotiating tactic.  Suddenly, the stakes involved in improving negotiation posture have been raised.

MBIA has several strategies available to counteract BAC's debt tender offer.  The $329 million 2034 notes that are the subject of BAC's tender offer can be prepaid at any time, at par plus the present value of future payments discounted at the current treasury rate of a comparable maturity plus 15 basis points (which, of course, is quite low and therefore this "make-whole" provision would be expensive).  So, MBIA could issue new notes in a private placement (having default provisions that would not be triggered by a Securitization Sub default) and redeem the 2034 notes even if BAC purchases them all.  This private placement can be closed in a week.  It will cost MBIA more than the debt cost for the 2034 notes, of course, but the point is that BAC's tender offer, if successful, does not prevent MBIA from pursuing its strategy.  It would just make it more costly.

MBIA could also go into the market and buy 2034 notes.  Any such notes bought by MBIA would not be deemed "outstanding" for purposes of its own debt consent solicitation, but it would lessen the amount of notes that would have to be bought by "friends of the family" in order to block the BAC tender offer strategy (and, of course, any 2034 notes MBIA bought in the market would lessen its prepayment cost).  As well, MBIA could conduct an exchange offer with holders of its 2034 notes, offering new notes without a cross default provision, and likely a higher interest rate and some cash, in exchange for the 2034 notes.

Finally, if indeed the consent solicitation is only a negotiating tactic and MBIA has multiple other paths to ensure sufficient liquidity at Securitization Sub to permit it to pursue its litigation with BAC to the end, MBIA could simply terminate its consent solicitation and pursue those other, likely more costly, strategies.  While terminating the consent solicitation may be difficult for MBIA to swallow, it would signal to the markets (and BAC) MBIA's belief that it is not exposed in the near and medium term to a NYDFS takeover of Securitization Sub.

Of course, MBA could also file a motion for a temporary restraining order (TRO) while it implements its corporate response strategy; while obtaining a TRO is not likely to be successful, seeking such a TRO would be considered good form in the world of hostile corporate transactions.

It now seems that the tail is wagging the dog, as if the decisionmakers at both MBIA and BAC are more interested in looking smart than astutely managing risk/reward. I am beginning to think that if Dickens were still writing, he would have a field day with all of this.

NB:  this blog is not intended to be investment advice, and should not be relied upon by anyone to constitute investment advice.  Investing is a tough game, and everyone must do and own their own work, because you will certainly own your investments.

Disclosure: long MBI.  Follow me on twitter.

Thursday, November 8, 2012

Is Bank of America's Article 77 $8.5 Billion Settlement Hostage to its Case with MBIA?

On June 28, 2011, Bank of America (together with its afilliates, BAC) entered into a settlement agreement (Settlement Agreement) with Bank of New York Mellon, the trustee (Trustee) of 530 mortgage-backed securitization trusts, under which the Trustee, on behalf of trust investors holding over $200 billion of mortgage-backed securities (mbs), agreed to release all fraud, breach of representation and warranty (R/W), and other claims (Released Claims) those mbs investors could assert against BAC for payment by BAC of $8.5 billion.

At the time this Settlement Agreement was entered into, these BAC mbs trusts had (i) already experienced losses in excess of $25 billion, (ii) losses on loans over 60 days delinquent that was projected to be an additional $50 billion, and (iii) further losses on loans in addition to these delinquent loans that was projected to be over $32 billion, aggregating a total amount of experienced and projected losses for these BAC mbs trusts equal to over $107 billion.

Interestingly, the Trustee and BAC could have simply closed the Settlement Agreement at the time of its execution during the summer 2011 by BAC's payment of money to the Trustee, and the Trustee's issuance of a release of the Released Claims to BAC.  While it was forseeable that the Settlement Agreement would have been challenged by some mbs investors who thought the $8.5 billion settlement amount was too low for the release of the Released Claims in connection with over $107 billion in expected losses, any such challenge would have been ajudicated on the merits based upon the reasonableness of the Trustee's consummation of these transactions under the Settlement Agreement in the summer of 2011.  Developments subsequent to a closing of the Settlement Agreement would not have affected the Trustee's reasonableness in releasing the Released Claims in exchange for receipt of $8.5 billion if those actions were closed and completed at that time.

Instead, the Trustee and BAC did something quite different.  They elected to postpone consummation of the transactions contemplated by the Settlement Agreement (the $8.5 billion payment and release of Release Claims) until a further condition was satisfied: obtaining judicial approval of the reasonableness of the Trustee's actions pursuant to an Article 77 action filed in the Commercial Division of the Supreme Court of New York.

Because the Settlement Agreement, by its terms, cannot be closed until Article 77 approval is obtained (or it is determined that it cannot be obtained, or the condition is waived), the transactions contemplated by the Settlement Agreement remain prospective with no legal effect unless and until such Article 77 approval is obtained.

There is a crucial distinction that must be kept in mind in connection with any analysis of the Trustee's reasonableness in an Article 77 proceeding: is the court in an Article 77 hearing determining the reasonableness of the Trustee in entering into the Settlement Agreement in the summer of 2011 (understanding that no payment was made and no claims released then), or is it determining the reasonableness of the Trustee's release of the Released Claims for payment of $8.5 billion when these actions are permitted to occur, under the Settlement Agreement?

The Settlement Agreement states:  "the terms of this Settlement Agreement are subject to and conditioned upon 'Final Court Approval' [judicial approval in an Article 77 proceeding that the Settlement Agreement expressly authorizes the Trustee to commence]...If at any time Final Court Approval of the Settlement shall become legally impossible (including by reason of the denial of Final Court Approval by a court with no possibility of further appeal or proceedings that could result in Final Court Approval), the Settlement Agreement shall be null and void and have no further effect as to the Parties...[except for provisions not relevant]" [emphasis added].

So, given that the Settlement Agreement is contingent and the transactions contemplated by the Settlement Agreement are prospective, the focus of the reasonableness of the Trustee in an Article 77 proceeding should be not whether it was reasonable for the Trustee to enter into the Settlement Agreement in the summer of 2011, but rather whether it is reasonable for the Trustee to perform the transactions...release the Released Claims for payment of $8.5 billion...only at such time those transactions are permitted to close and have legal effect.

Therefore, any inquiry into the reasonableness of the Trustee should remain an open question subject to legal developments post-summer 2011 until such time as the Settlement Agreement is enforceable against BAC and the Trustee...and that will only occur when Article 77 proceeding has been completed and a favorable decision rendered, such that the transactions contemplated by the Settlement Agreement can have legal effect and be consummated. 

The Article 77 schedule contemplates a hearing schedule that will last well into the spring of 2013 with a decsion by Justice Kapnick expected much later in 2013 (considering that Justice Kapnick has not yet issued her opinion in the BAC Article 78 hearing against MBIA and the NYDFS that concluded in June 2012).

So, this raises a fascinating question: what happens if the legal analysis that the Trustee obtained in the summer of 2011 that, in its view, supported the reasonableness of the transactions contemplated by the Settlement Agreement, is rendered stale or wrong by judicial holdings subsequent to the summer of 2011, such that at the time the Trustee seeks to obtain judicial approval to consummate the Settlement Agreement transactions (the only time the Trustee can enforce the Settlement Agreement against BAC), the Trustee's actions can no longer be fairly regarded as reasonable?

It so happens that this fascinating, and financially momentous to BAC, question is presented with full force in the MBIA v. BAC fraud and R/W litigation currently approaching trial before Justice Bransten in the same court as the Article 77 proceeding. Incredibly, it is BAC, itself, that is pursuing a strategy in the MBIA litigation that, given Justice Bransten's judicial decisions to date and motions that are expected to be argued just next month in this litigation, is creating judicial doubt as to the reasonableness of the Trustee's consummation of the Settlement Agreement with BAC.

I have stated in this blog before, here, that BAC's litigation strategy in the context of its legacy Countrywide mbs claims appears idiotic and self-defeating, by creating adverse judicial precedents in the MBIA proceeding that can be applied against BAC by the use of offensive collateral estoppel in much larger proceedings against it.  BAC's strategy to continue litigation with MBIA risks creating additional judicial precedents that effectively makes the Article 77 proceeding a hostage to BAC's MBIA litigation.  It must be kept in mind that through the assertion of offensive collateral estoppel, it is generally the case that any judicial finding of law and fact in the MBIA litigation adverse to BAC that is at issue in the Article 77 proceeding can be enforced against BAC by objecting mbs investors.

This appears to me to be just another example of breathtakingly stupid legal risk assessment by BAC's executives and board of directors.

Monday, October 29, 2012

A Mediator's Perspective on the MBIA v Bank of America Litigation---Part 2

I have discussed previously how from a mediator's perspective the litigation between Bank of America (together with its affiliates, BAC) and MBIA (MBI) is highly susceptible of settlement.  Both pieces of litigation, the Article 78 action brought by BAC against MBI and the New York State Department of Financial Services, and the fraud and breach of representation and warranty actions (R/W) brought by MBI against BAC, have been at issue with third parties in the same or identical litigation, and have been settled by MBI and BAC, respectively, to their satisfaction with those third parties.

So given this background, a mediator would go into a caucus with BAC and prepare a spreadsheet with BAC listing all of the R/W actions that it has settled as defendant with third parties, take an average, adjust that average for characteristics relevant to the MBI action (for example, since the MBI R/W action is closer to trial than other R/W actions BAC has previously settled, the average payment should be adjusted upward by a certain amount), and then obtain BAC's agreement to present that adjusted average of prior settlements as a reasonable offer to MBI.  If such a reasonable BAC offer can be constructed in this fashion that takes into account settlements that third parties standing in MBI's shoes found acceptable, the offer may be presented in a fashion that puts the onus on MBI to show why it is reasonable for MBI to insist on more.

Likewise, a mediator would go into a separate caucus with MBI and prepare a spreadsheet with MBI listing all of the plaintiffs in the same Article 78 action that BAC brought that MBI has settled with, and the various amounts MBI paid to commute its insurance of the plaintiffs' commercial mortgage backed securities (cmbs).  Again, this average would be adjusted for any characteristics relevant in any commutation of BAC's insured cmbs, and the mediator would obtain MBI's agreement to present that adjusted average of prior commutation amounts as a reasonable offer to BAC.  If such a reasonable MBI offer can be constructed in this fashion that takes into account commutations that third parties standing in BAC's shoes found acceptable, the offer may be presented in a fashion that puts the onus on BAC to show why it is reasonable for BAC to insist on more.

Of course, BAC and MBI each would likely insist on more, as is the prerogative of every negotiator engaged in a settlement negotiation.  The obligation of the mediator at this point is to devise one or more "bridging the gap" strategies or arguments that will convince the parties to "settle in the middle" once the reasonable offers discussed above can be constructed.

I have found as a mediator that there are two bridging the gap opportunities that are particularly useful:  (i) having the payor pay with "fifty cent dollars", and (ii) finding "freebie bennies" for the payee.  Interestingly, both bridging the gap opportunities are present in the case of the BAC v MBI litigation, leading me to believe that this litigation is especially amenable to settlement.

Tuesday, October 16, 2012

Can Bank of America Shift the Blame?

In Countrywide's motion for summary judgment (SJ) on primary liability to MBIA (MBI), filed September 18, 2012 but unsealed subject to redactions on October 5, 2012 (SJ), Countrywide (together with its affiliates, BAC) led off by reiterating its single over-arching theory of the case: it's not our fault that there have been many tens of billions of dollars of losses on our securitizations, it is the fault of something else (the housing crisis) or someone else (MBI itself).

BAC's claim that the housing crisis actually caused these mbs losses may actually be true in a historical, non-litigation sense. The prevailing meme at the time of these massive mbs securitizations was that as long as housing prices continued to go up, even blindly-underwritten mortgages would be repaid.  The housing crisis certainly punctured that blind faith balloon.

However, there is the matter of those pesky representations and warranties (R/W) that BAC made to mortgage investors and mortgage insurer MBI in the securitization documents; the same BAC R/Ws that MBI alleges in its SJ that BAC materially breached with respect to over 56% on the mortgages in the securitization pools MBI insured. MBI goes on to assert that BAC cannot contest that it breached its R/Ws with respect to these mortgages.

BAC's initial attempt to shift the blame was based upon its loss causation theory.  BAC argued that it could avoid liability on its R/W breaches in the securitization documents unless the damaged party could show that those R/W breaches, rather than the housing crisis, caused the losses incurred by MBI and mbs investors.

This initial attempt by BAC to shift the blame was denied by Justice Bransten in her summary judgment ruling on 1/3/12 regarding loss causation.  She found that BAC could be held liable to MBI under the transaction documents if BAC's R/W breaches materially increased MBI's risk of loss.  There was no need to show that the R/W breaches themselves caused the losses.  She went further to hold that MBI could obtain recissionary damages (recovery for all its losses incurred in insuring the securitization pool, not just losses for loans that individually breached the R/Ws).

The rejection of this loss causation theory that would have permitted BAC to shift the blame has since been seconded by two influential federal district court judges (Crotty and Rakoff) in similar mbs insurance cases.

Now, BAC seeks to shift the blame once again under another theory, by alleging that it can't be held liable to MBI for losses if MBI was aware (or should have been aware) of BAC's many breaches of R/Ws.  BAC argues that MBI was put on notice of BAC's R/W breaches by virtue of the results of third party due diligence reports (conducted by firms retained by underwriters in connection with the offering of the mbs securities).  BAC adds that it provided MBI digital records of the mortgage loans (mortgage tapes), and their contents should have put MBI on notice of BAC's R/W breaches.

Moreover, even though BAC cannot argue that its R/W breaches did not cause MBI's losses, it can still try to show at trial that its R/W breaches did not materially increase MBI's risk of loss.

The question now presented to Justice Bransten is whether BAC will prevail in its second attempt to shift the blame.  Interestingly, Judge Rakoff's recent evidentiary holding in the now current trial of Assured Guaranty v Flagstar may provide ample insight into how this might play out before Justice Bransten.

Monday, October 15, 2012

A Mediator's Perspective on the MBIA v Bank of America Litigation

Many commentators have questioned why the MBIA (MBI) v Bank of American (BAC) mortgaged-backed securities (MBS) litigation has not been settled by now.  This litigation consists of MBI's fraud and breach of representation and warranty (R/W) suit against BAC in connection with MBI's issuance of insurance guarantying timely payment of the mbs interest and principal, and BAC's suit against MBI and the New York State Department of Financial Services challenging the transformation of MBI, creating separate securitization and municipal finance guaranty subsidiaries.

Absent any examples of what the parties agreed to in nearly identical situations, as discussed below, one would anticipate that settlement negotiations of the fraud suit would likely involve offers and counteroffers in the range of approximately $1-5 billion, and settlement negotiations of the transformation suit and commutation of insurance wrapping BAC's commercial mbs would likely involve offers and counteroffers of approximately $.5-$2.5 billion.  Big dollar amounts and big ranges. At first blush, difficult to settle.

Yet, BAC seems to be worsening its legal position, and hence its negotiating position, as the litigation continues.  BAC has lost important rulings regarding whether, among other things, MBI must prove that BAC's R/W breaches caused the loans MBI insured to go into default, or whether these breaches merely adversely affected MBI's interest in insuring the mortgage pools, and whether MBI must identify each loan that breached BAC's R/Ws, or whether MBI can prove BAC's breaches and MBI's damages by resorting to a statistically significant sampling of all loans.  On the horizon stands an important argument regarding parent BAC's successor liability for Countrywide's primary liability, another issue that BAC surely does not want to lose.

Moreover, as this litigation now stands in the shadow of an anticipated New York Attorney General (NYAG) template suit against BAC for all investor losses and for the integrity of the securities marketplace, all litigation losses BAC incurs are magnified by the ability of the NYAG to bring its much larger suit and use these BAC losses as proof of the NYAG's allegations and theories of the case by means of offensive collateral estoppel.

Given that there are such significant benefits for BAC to settle with MBI, isn't the absence of a settlement to date simply an example of the difficulty of settling such a large-scale, big money litigation?  Aren't the barriers to reaching a negotiated settlement of this complex situation so high as to make litigation the only practical conflict resolution medium?

The answer is absolutely no!  Indeed, these two interrelated actions between MBI and BAC share a huge advantage with respect to the likelihood of achieving settlement, as compared to the typical settlement negotiation that, from a mediator's perspective, make the BAC and MBI actions not only not difficult to settle, but particularly susceptible of settlement! To understand why, continue reading following the jump.

Friday, October 12, 2012

Did Bank of America Asset-Strip Countrywide? Were CEO Moynihan's Statements Vague and Informal?

Did Bank of America (BAC) engage in asset stripping of Countrywide after its 2008 acquisition? Did BAC pay fair value for those assets by making a contemporaneous payment to Countrywide of fair value, or is BAC crediting capital contributions it made to Countrywide to fund Countrywide settlements of MBS litigation? Does it even matter whether BAC paid fair value for the transfer of Countrywide's assets? And even if BAC paid fair and contemporaneous value to Countrywide for the transfer to BAC of Countrywide's entire mortgage platform, was Countrywide left with insufficient assets in view of its massive contingent liabilities and, with no operating business remaining, no means to generate funds to pay them?

Did BAC executives engage in "vague and informal" statements regarding BAC's assumption of Countrywide's liabilities, as alleged by BAC, or do the statements by BAC's CEO and CFO regarding payment by BAC of Countrywide's liabilities "when they are due" constitute  BAC's formal and considered assumption of Countrywide's liabilities because of such practical business realities as avoiding severe reputational harm to BAC's franchise itself? And do the various instances when BAC funded Countrywide's litigation settlements provide the best evidence of this practical business reality?

The answers to these simple questions will go a long way in deciding whether BAC will be found to have successor liability for Countrywide's liabilities.

Monday, October 8, 2012

Bank of America's Idiotic Litigation Strategy and Why the New York Attorney General is Licking His Chops

Bank of America's (including its affiliates, BAC) mortgage backed securities (MBS) litigation with MBIA (MBI) has just entered a new and dangerous phase, and BAC appears clueless, confused and exposed.

On October 5, 2012, MBI and BAC filed motions for summary judgement in MBI's fraud and breach of contract action against BAC.  These filings stand in the shadow of the New York Attorney General's filing of a fraud action against Bear Stearns and its parent J.P. Morgan (collectively, JPM) on October 1, 2012. The NYAG stated that its JPM action would serve as a template for additional actions against MBS issuers and originators. In other words, BAC was put on notice that it would be a likely target for a follow-on suit brought by the NYAG, for which its JPM suit would serve as a template. 

Given the NYAG's special statutory powers and reduced evidentiary burden, and the ability of the NYAG to piggyback on any private action by obtaining not only a litigation roadmap for its action but also, importantly, the ability to use collateral estoppel to have findings of fact and legal issues proven in any private action also proven for the NYAG's case, all as discussed below, BAC inexplicably led with its chin in its summary judgment motion, and all but invited the NYAG to launch its case based upon BAC's very own work product.

BAC's litigation strategy has often been criticized for lack of foresight in its failure to settle with MBI.  Now, BAC can fairly be accused of idiocy as its own papers offer the NYAG a crisp first draft for the NYAG's contemplated template action.