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.

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