Saturday, January 26, 2013

With Bank of America Now on the Clock, Even the Financial Analyst Community Wants to Know

I have posted that I believe Bank of America (BAC) will lose MBIA's motion for summary judgment on successor liability, at Why Bank of America Will Lose on Successor Liability, and how this has the potential to blow apart BAC's $8.5 billion settlement with the "Gibbs & Burns" institutional investors, at Is Bank of America's Article 77 $8.5 Billion Settlement Hostage to its Case with MBIA?

So, BAC is now on the clock, perhaps having some three months to decide whether it will settle with MBIA before Justice Bransten hands down an adverse successor liability holding.  My guess is that BAC will settle, as discussed at Bank of America Successor Liability, the Article 77 Case, and Settlement Game Theory .

But now curious minds among the financial analyst community also want to know about BAC's financial exposure to an adverse successor liability ruling, and at least one such analyst had the onions to press BAC management about BAC's strategy in this regard on BAC's recent earnings conference call last week:

We will go next to the site of Mike Mayo [with] CLSA. Your line is open.

Q - Mike Mayo: Okay. That's fine. And then going to the mortgage put backs and the - so the Fannie settlement, you got that done. Sounds like you're feeling better about the rep and warranty expense. I think I heard you saying it might go from $300 million to $150 million per quarter, so I sense you're feeling better. I'm trying to reconcile that with what's taking place with the MBIA versus Countrywide court moves; and correct my thinking if anything's wrong here, but I think it's an issue of Bank America's successor liability? Or is Bank America responsible for Countrywide? And as of January 9th and 10th the oral arguments were completed so I understand it's in the hands of Judge Branston [ph], the New York State Supreme Court and the motion says that Bank America is responsible for Countrywide. And if so, I guess that could put the $8.5 billion private label settlement at risk. So my question is, could that $8.5 billion settlement be at risk? Do I understand what's happening in the court correctly? And what happens if the $8.5 billion private label settlement does not go through?

A - Bruce R. Thompson: I think a couple things on that, Mike. First, I think it, from our perspective, the $8.5 billion Gibson Bruns [ph] settlement is going through the court process, would likely get wrapped up sometime in the second quarter or early in the third quarter. And that's completely independent from what's going on at MBIA. With respect to MBIA in the broader monolines, as we've said before, generally with - if you look at geography within the financial statements, the majority of the work that we do and where the monolines are accrued for at this point is within the litigation line item as opposed to within our provision for reps and warranties. And the third thing I would say is that, as it relates to kind of the general rep and warrant question, I think the most important thing to go back to is that virtual - the large majority of everything that was done with the GSEs at this point between our global settlement with Freddie and Countrywide and our global settlement with both Countrywide and Bank of America, with the GSEs just takes away a significant amount of risk relative to where we've been before.

Q - Mayo: So we're really just talking private label at this point?

A - Bruce R. Thompson: You've got the - as I referenced, you've got the several monolines that we're working through on a litigation perspective and then you're right, you've got the private label piece. And I think if you go back to the comments that we made about the geography and the representations and warranties you can see we have a pretty sizable amount set aside to work through the private label exposures.

Q - Mayo: So what is the significance of the decision by Judge Branston [ph] and the New York State Supreme Court? There was a Wall Street Journal article on January 11, some other chatter saying that if this motion goes against you and your team's responsible for the legal liabilities of Countrywide, then that could be a negative event for you. Do you agree with that?

A - Brian T. Moynihan: Mike, I mean we could - I think if you think about this litigation goes back and forth and the judge has a lot of decisions to make in a lot of cases and we'll play it out here. But we're comfortable with our legal positions across the board.

Q - Mayo: Okay. But for that we should - you think we'll hear next month as opposed to midyear?

A - Brian T. Moynihan: I'm not sure the exact time.

Q - Mayo: Okay. Just last question on that because I'm don't - I'm just trying - how do we get our arms around that risk? That's really my question. And so if you wanted to just give advice to somebody, okay here's the potential hit if things go wrong, what would be your answer to that or just - is there no answer?

A - Bruce R. Thompson: I think what you - what I would suggest you do, and I'm not going to quote somebody else's financial statements, but I think you can go look on MBIA's financial statements and see how much that they believe that we're owed - or that they're owed from us. That's disclosed in their financial statement so you can look at that. And then the corollary is I think you have to keep in mind that there is a significant amount of money that they owe us within our Global Market business that's very significant that we have marked at cents on the dollar."

Some thoughts: 

First, in response to Mayo's question regarding quantification, how to get our arms around the risk, BAC's CFO pointed to MBIA's insurance recovery receivable, which stood at $3.3 billion at the end of 3Q '12 (raised $300 million from year end 2012).  This is remarkable, because it seems to indicate some acceptance on BAC's part that this amount is appropriate to think abount in terms of BAC's exposure.

I don't mean to suggest that BAC endorsed MBIA's settlement receivable figure at all.  But if BAC wanted to signal that it thought this figure was unacceptable, it wouldn't have made sense to have referred to it.

Now, this $3.3 billion is a gross number inclusive of all MBIA counterparties, but given Residential Capital's insolvency and that MBIA's other actions against originators are nowhere near as mature as its case against BAC, this number is probably a good proxy for what BAC believes is the minimum amount it expects MBIA is willing to receive from BAC, understanding that good accounting practice would dictate that this receivable should be presented on a conservative basis.

So, even though addressed in an oblique manner, this is the first time that I can recall a BAC executive addressing exposure to MBIA in actual dollar terms, as opposed to referring to some opaque reserve line item on its balance sheet that sheds no light.

Second, the BAC CFO's assertion that the Article 77 hearing is "completely independent from what's going on at MBIA" insults your, my, and Mayo's intelligence.  Now, I am aware that in any conflict negotiation, neither side wants to credit the other side's argument, certainly not in public.  But, I think you do your side a disservice if you don't maintain at least a veneer of rationality and good sense.  To do otherwise does not engender confidence.

[To beat a dead horse just one more time, at the core of the Article 77 settlement at pennies on the dollar of actual and projected losses is the argument that BAC does not have successor liability.  It is indisputable that it will be harder to gain judicial approval of this settlement in 2013 if there is now a judicial holding otherwise, even if the reasonableness of the settlement is measured as of the state of affairs in 2011.  But one has to wonder why the reasonableness of the settlement would not be measured as of the state of affairs in 2013, given that the settlement is open and contingent, and unenforceable by either party at the current time, rather than a closed and done deal.  See further Is Bank of America's Article 77 $8.5 Billion Settlement Hostage to its Case with MBIA?]

The CFO's statement that the judicial approval of the Article 77 settlement will likely get "wrapped up" in the second, perhaps third, quarter of 2013 not only ignores the effect of any interplay, his anticipated schedule is highly questionable. Justice Kapnick has made clear in the Article 78 proceeding that she will allow the parties ample time to present their cases, and she will allow herself more than ample time to decide the case. Given the pre-hearing discovery disputes that are on-going, the commencement of the Article 77 case, currently scheduled for May 2013, may be delayed well into the third quarter.  As for its resolution?  A BAC CFO prediction of second or third quarter 2013 just makes you scratch your head.

Third, BAC's CFO reference that it has marked down its cds swaps from MBIA to "cents on the dollar" sounds quite strange, as the BAC CEO has previously stated in an interview that MBIA was only offering cents on the dollar to commute this exposure, and he didn't understand why BAC should accept this.  So, is the BAC CFO saying that BAC has written down its cds swaps to MBIA's bid?

Fourth, BAC's CEO's statement that we are "comfortable with our legal arguments across the board" is his typical non-answer answer, and he should be embarrassed by now when he hears himself give it.

After all, this is the same CEO who told the money honey on national television that the mbs cases would involve "hand to hand combat, loan by loan" (wrong, extrapolation of loan sampling has been uniformly granted in New York), and that the plaintiffs would have to prove that BAC breaches caused their losses, which they can't do given the intervening financial crisis (wrong, only causation showing necessary is to show that BAC breaches increased risk of loss).  You would think Mr. Moynihan would have moved off this type of patronizing reply by now, given that BAC is over $20 billion down the road in settlements.  Reality check!

As this might be the last BAC earnings conference call before Justice Bransten is in a position to rule on successor liability, this may be a case of "watch what we do, not what we say" with 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, January 23, 2013

Why Bank of America Will Lose on Successor Liability

It is important to keep in mind what are the relevant facts and legal arguments when considering whether MBIA will be granted summary judgement (SJ) on its motion that Bank of America (BAC) has successor liability for the liabilities of Countrywide.

MBIA's principal argument is that on the facts of the case, BAC has successor liability for Countrywide's liabilities based on the New York law of de facto merger.  De Facto merger is one of the few exceptions to the corporate law principle that an acquiror of assets (BAC) doesn't thereby also acquire the transferor's (Countrywide's) liabilities. Another separate and distinct exception to this corporate law principle of non-successor liability is the theory of fraudulent conveyance.

BAC's counsel misstated the legal parameters of the de facto merger doctrine and emphasized irrelevant facts in its argument before Justice Bransten by trying to conflate the theory of de facto merger (which requires no analysis of the consideration received in connection with a transfer of assets) with the separate theory of fraudulent conveyance (which is all about whether assets were transferred for less than full value).  Since the facts of the case don't support the theory of fraudulent conveyance as easily and neatly as they support the theory of de facto merger, BAC essentially defended against MBIA's claim of de facto merger by arguing that there was no fraudulent conveyance.  This may be true, but it is quite beside the point.

I do not believe that Justice Bransten will be confused by BAC's attempt to conjure lemonade from lemons.  I use this euphemism because it appeared that BAC went to great length to conduct its acquisition of Countrywide in a way such that it would acquire all of the operating assets and business (including management) of Countrywide (the Countrywide mortgage platform), and insulate itself from liabilities it did not want to assume (or which BAC would agree to assume only on its own terms), but would not contravene applicable fraudulent conveyance law.  However, BAC was blind in its execution of this transaction plan to the applicabiity of de facto merger law, which is an alternative and well-developed theory that applies irrespective of BAC's attempt to avoid a fraudulent conveyance claim.  So, in having to defend a case whose facts squarely present a strong case of de facto merger, BAC's counsel tried to show how the facts don't satisfy the fraudulent conveyance theory, and hope the judge doesn't get it.  Lemons to lemonade legal advocacy.

To appreciate why I think Justice Bransten will get it and grant MBIA's SJ motion on BAC successor liability, we will first address the facts of the case, almost all of which are uncontested, analyze the New York doctrine of de facto merger and why it's application is especially well-suited to the facts of the case, and consider whether Justice Bransten is likely to apply the law of any jurisdiction other than the New York law of de facto merger.

Sunday, January 13, 2013

Bank of America Successor Liability, the Article 77 Case, and Settlement Game Theory

Now that MBIA and Bank of America (together with its affiliates, BAC) have concluded arguments on MBIA's motion for summary judgment (SJ) regarding BAC successor liability before Justice Bransten, one can contemplate what BAC's next move will be in its legacy mbs liability saga.

This is no idle speculation as MBIA is a value investor's poster child.  MBIA is a stock that is trading at substantially less than adjusted book value (abv) (and if you believe MBIA's abv, specifically, the receivable MBIA has booked for anticipated mbs insurance recoveries, then you believe that MBIA is trading substantially below its intrinsic value).  As well, MBIA is subject to the possible near-term catalyst represented by Justice Bransten's ruling on BAC's successor liability.

Of course, whether that catalyst will be positive or negative for MBIA's share price is what makes a market.  So the prospects of a near-term MBIA/BAC settlement in advance of that ruling is an important inquiry for an MBIA shareholder (or short).

Therefore, it is not too early to assess what settlement strategy BAC may now wish to pursue, since i) as they say at the Casino de Monaco, "les jeu sont fait, rien ne va plus"...the bets are down, nothing more goes on the table...because nothing more is required to obtain Justice Bransten's ruling other than the simple passage of time, unless there is a settlement with MBIA that dismisses the case, and ii) BAC may have adopted a strategy to accelerate its disposition of legacy mbs liabilities, as it has recently settled claims asserted by Fannie Mae for $11.6 billion at what appears to be about 100 cents on the dollar of claims.  (see

It is also not too early to make this assessment because the two principal MBIA analysts, Harry Fong of MKM Partners and Mark Palmer of BTIG Research, already are out with their prognoses.  See Palmer and  Fong.  While both agree that BAC would be well served to engage in settlement discussions now that the question of BAC's successor liability is teed up and squarely in Justice Bransten's capable hands, Palmer analyzes the possibility of BAC settlement with MBIA in order to protect the advantageous Article 77 settlement, whereas Fong instead analyzes the possibility of BAC settlement with institutional investors and states attorneys general (collectively, the intervenors) who have objected to the Article 77 settlement, rather than settlement first with MBIA.

How long does BAC have until Justice Bransten can be expected to rule in order for any such settlement scenario to play out?  Fong sensibly points to the three month time period Justice Bransten needed to render her causation decision and suggests this as a guide.  Since it would make sense for Justice Bransten to issue her SJ opinions regarding primary liability (argued in the middle of December) and successor liability either at the same time or in close proximity, one might even expect Justice Bransten to take as long as four months to issue these twin opinions simultaneously.  But does it make sense for BAC to tempt the litigation gods and take four, three or even two months before it consummates any settlement it wishes to pursue before Justice Bransten makes her ruling?

So given that the two principal MBIA investment analysts have identified alternative BAC settlement strategies, one can engage in a little exercise of game theory analysis to conjecture which settlement strategy makes the most sense for BAC to pursue.  While I won't try to posit a Nash Equilibrium or use a von Neumann decision tree for this game theory analysis, I hope to explore what one might reasonably expect from BAC by taking into account BAC's incentive structure, as well as the incentives of MBIA and the Article 77 intervenors.

It seems to me based on this analysis that if BAC decides to puruse any settlement strategy before Justice Bransten renders her successor liability opinion, the rational choice would be to settle with MBIA first. 

Tuesday, January 8, 2013

A Couple Curious Tea Leaves

Justice Bransten held a hearing yesterday in which she authorized Courtroom View Network's (CVN) application to stream the arguments to be held tomorrow and Thursday regarding the motions for summary judgment (SJ) on Bank of America's (together with affiliates, BAC) successor liability for Countrywide's liabilities.

Justice Bransten is a thoughtful judge and when she addressed BAC's concern as to whether the public airing might adversely affect future jury trials involving BAC, Justice Bransten handled the concern sensibly and was convinced that no such taint would arise when CVN stated that they had about 500 regular subscribers, mostly law schools, apart from those that might buy a daily subscription ($250) to see the successor liability argument only.  So while access to the arguments will go beyond the normally-available-for-purchase court transcripts, we are talking more about an indie release than prime time when it comes to CVN.

But then the discussion turned to certain organizational matters relating to the successor liability arguments, and Justice Bransten made two interesting comments: i) even though MBIA had the burden of proof on the issue of successor liability (essentially de facto merger), she wanted BAC to argue first, and ii) she did not think she would need to read documents relating to the BAC/FNMA $10 billion settlement announced just that morning, as she thought she would be able to make her decision on the papers as presented and on the "gist" of the case, as she put it.

Now these are just tea leaves and one should not invest tea leaves with much, if any, meaning.

But I do find it curious that she wanted BAC to argue first even when it did not have the burden of proof on successor liability (indeed, MBIA counsel appeared surprised at this decision as well), which is to be argued Wednesday.  One might think that the party with the greater need to pull the oar, so to speak, would usually go first...and maybe in Justice Bransten's mind, it will.

As to the BAC/FNMA settlement papers and whether their production could be obtained on an expedited basis, when BAC counsel advised that it did not represent BAC on that matter and didn't have the papers, Justice Bransten was unconvinced that even such a large settlement by BAC of Countrywide liabilities (Justice Bransten apparently was unaware of the settlement and interrupted MBIA counsel when he said $10 billion) would affect her treatment of the implied assumption of liability argument, which is to be argued Thursday.  The papers would be produced in due course.

If I were asked what my takeaway from all this is, I would caution first that this is only tea leaf reading...but it certainly seems like it represents a signal from a judge who (having read all the papers before argument, not always the case among NY Supreme Court judges) is inclined to rule in MBIA's favor on the de facto merger prong of successor liability, and therefore need not spend much time addressing the independent implied liability assumption argument (which Justice Bransten would need to address only if she ruled against MBIA on de facto merger).

Just tea leaves, however.

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.

Saturday, January 5, 2013

Freaky Friday, a Non-Event Sealing Opinion, and a Modest Proposal

Yesterday was freaky friday for MBIA's common stock, trading over 10 million shares, compared to a daily average (for the trailing three months) of less than 3 million shares, and the MBIA common stock closed at $9.09, up almost 12% for the day.  Moreover, there was some curious trading in the January 19, 2013 calls, with over 31,000 contracts (representing 3,100,000 shares) traded in the $9, $10 and $11 calls.  Only about 2,000 corresponding puts were also traded, so it appears that the heightened option activity was not an instance of sophisticated hedging, but rather the establishment of speculative positions. 

Curious minds might wonder why?

One putative explanation is that during the day Justice Bransten released her order regarding Bank of America's (together with its affiliates, BAC) motion to seal various exhibits to MBIA's motions for summary judgment (SJ) on primary and successor liability.  The SJ motion for primary liability was argued December 12-13, 2012, and the SJ motion for successor liability will be argued this coming week.  Indeed, Justice Bransten may decide January 7 to permit the successor liability arguments to be televised.  So perhaps the reason for the spike in MBIA's common stock activity can be attributable to the sealing decision or the prospective successor liability SJ argument.

The sealing decision, however, was largely a non-event.  It can only be described as a split decision, as BAC was able to seal most of the confidential reserve data and calculation information that it wanted to keep secret, and the only BAC settlement information that Justice Bransten ordered unsealed related to a settlement the terms of which were at least partially disclosed (and as is BAC's wont, created as many questions as it answered).  So, either the market suffered an utter headfake if it was basing its upward bias on the unsealing decision, or the explanation for the trading froth lies elsewhere.  For that, readers might speculate as well as I can.

But as to another matter of speculation, I can offer a modest proposal.

It does occur to me that BAC's desire to maintain confidentiality, and indeed even create confusion, over the terms of any settlement with MBIA could be exploited by MBIA if MBIA were to propose a settlement structure that would involve the sale by MBIA of stock of MBIA Insurance (Securitization Sub) to BAC.  Securitization Sub is both the obligor on the cds that BAC holds that MBIA wishes to terminate, and the beneficiary of any payment by BAC in settlement of MBIA's fraud and putback actions against BAC.  Apart from these transactions, Securitization Sub maintains a rather noncontroversial investment portfolio backing an insurance guaranty exposure that should be relatively easy to value.

The benefit of settling the MBIA v BAC fraud and putback actions as well as the BAC v MBIA article 78 action and the commutation of the cds by means of a sale of Securitiztion Sub is that BAC would have substantial lattitude to account for the transaction in the manner it sees fit, and its public disclosures regarding the transaction would be couched more in terms of purchase price for Securitization Sub stock than the cost of settling any legal action.

For example, suppose hypothetically that MBIA and BAC were to agree to a net payment by BAC to MBIA of $2 billion in settlement of all legal actions between them and the commutation of the cds, and that Securitization Sub's remaining value, ex-litigation, was $300 million.  This $2 billion settlement could be structured as a $2.3 billion sale of Securitization Sub by MBIA to BAC ($1.6 billion of this purchase price would pay off Securitization Sub's borrowing from MBIA), and no specific disclosures of the amounts paid in settlement of any claims need to be made.

Moreover, BAC could avoid taking any hits to its earnings if it has under-reserved for the fraud and putback actions and maintained a higher carrying value for its cds.  Rather, BAC would apply this $2.3 billion purchase price to the carrying value it would establish for the Securitization Sub stock that it just purchased.  This sleight of accounting would involve a conversation between BAC and its accountants, of course, in which, one suspects, BAC would be rather persuasive.

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.