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.