Tuesday, April 30, 2013

MBIA Wins on the Law But Must Go To Trial. Has the Settlement Bid/Ask Spread Just Narrowed?

The Summary Judgment Decisions

On April 29, Justice Bransten rendered decisions with respect to Countrywide's primary liability and Bank of America's successor liability to MBIA.

The executive summary is that on every material question of law that Justice Bransten considered in these motions, Justice Bransten ruled in favor of MBIA.  However, Justice Bransten also found that with respect to most of the claims covered by these decided questions of law, there was a sufficient factual dispute raised by Bank of America (BAC) to warrant going to trial to resolve these issues of fact.

The burden of proof for MBIA on a summary judgment motion is to show that there is no genuine dispute as to fact with respect to a claim.  While the standard is the same, different judges interpret this summary judgment standard in the context of disputed facts differently, with some judges looking harder to see if the dispute is real, or is in reality simply conjured up by a defendant in order to get to trial.

Justice Bransten is not that judge, and she gave BAC the benefit of the doubt with respect to questions of fact that BAC was able to raise.

It should be remembered, however, that the burden of proof to establish a fact at trial is much easier for MBIA to surmount than on motion for summary judgment.  If the burden of proof at summary judgment is that MBIA had to establish a fact with a 95% degree of certainty, that burden goes down to 51% at trial.

With respect to the motion for summary judgment on BAC's successor liability, I have posted earlier, Why Bank of America Will Lose on Successor Liability, that Justice Bransten would apply New York law with respect to the issue, and would apply New York's law on de facto merger without grafting any requirement that the asset transfer be made for less than adequate consideration, which was argued by BAC.

On these questions of law, I was right and Justice Bransten ruled completely in favor of MBIA.  Because of this, I also thought that there was a 75% likelihood that Justice Bransten would grant summary judgment on successor liability, as I did not discern any genuine questions of fact raised by BAC in the briefing papers, as most of the facts alleged by MBIA came directly from BAC documents or BAC deponent testimony.  On this I was wrong.

In walking through the four part de facto merger test under New York law (" The four "hallmarks" of de facto merger under New York law include: ( 1) continuity of ownership; (2) cessation of ordinary business and dissolution of the acquired corporation as soon as possible; (3) assumption by the successor of liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation; and (4) continuity of management, personnel, physical location, assets and general business operation.), Justice Bransten found that BAC raised questions of fact that precluded a determination at the summary judgment stage.

I would not quibble with any of these determinations, except to the extent Justice Bransten gave credence to a BAC argument that it was significant that Countrywide transferred assets to BANA, a subsidiary of BAC, rather than BAC itself.  Justice Bransten seems to believe this calls into question whether BAC directly controlled this transfer, which was a factual question she felt she couldn't determine on summary judgment.

I believe the important factual analysis is whether Countrywide transferred assets out of Countrywide itself, and those assets were continued as a mortgage platform business operated by BAC, whether directly or through a subsidiary.  Even using the very thin reed standard of factual dispute that Justice Bransten employed at the summary judgment stage, it does not seem to me to be relevant where the assets went as long as BAC was the ultimate parent entity of the transferee. 

At trial, if there is a trial as I discuss below, I would have to conclude that MBIA's chances of prevailing on BAC's successor liability are at least 75%.  What Justice Bransten did in her opinions, both for BAC successor liability as well as Countrywide primary liability discussed below, was provide MBIA a trial roadmap, showing MBIA what questions of fact MBIA needs to concentrate on and bolster, understanding that MBIA need only show a preponderance of the evidence to prevail. 

Importantly, there are no legal issue hurdles contained in this roadmap, and no factual proof showing would appear to be problematic to MBIA.

As for Countrywide's primary liability, again it was a clear victory on the law for MBIA and a victory for BAC to get to a trial.

The most important legal issue argued by BAC was that MBIA's recovery for both of its fraud and breach of contract claims under insurance law as well as contract law was limited to the contractual remedy of pursuing the repurchase protocol, as a "sole remedy."  

Justice Bransten flatly rejected this BAC argument, and held that MBIA was entitled under the insurance law to pursue compensatory damages, even as the 1st Department recently held that recissory damages was unavailable.  Apparently, BAC counsel's letters to Justice Bransten after the 1st Department decision were not persuasive.  See Did the New York Appellate Court Just Eliminate Bank of America's "Sole Remedy" Defense?

This availability of compensatory damages under insurance law was a huge win for MBIA as it does not require that MBIA reasonably relied upon the representations and warranties (R&W) made by Countrywide, but only that MBIA would not have issued its insurance policies had it been aware that the R&Ws were breached by Countrywide.  Justice Bransten specifically found that, under the insurance law claim that she found was not barred by BAC's sole remedy argument, no reasonable reliance showing need be made by MBIA.

Moreover, Justice Bransten found that performing loans that breached R&Ws were subject to repurchase in all of the securitizations at issue, and not just the one securitization addressed by the 1st Department when it ruled in MBIA's favor on the question.

Again, as with the successor liability holding, Justice Bransten stopped short of concluding that BAC was in material breach of its R&Ws, and that material breach had a material and adverse effect upon MBIA, holding that these were fact-intensive inquiries that she would reserve for trial.  Let's remember, however, from Judge Rakoff what is the material and adverse effect standard that MBIA must show at trial...namely, that MBIA incurred an increased risk at loss at day one of the securitizations, understanding that risk of loss may or may not result in actual loan defaults.

In this regard, I would take Justice Bransten to task for finding that there was a genuine issue of fact with respect to the definition of "qualified appraiser" for purposes of that BAC R&W.  This breach affects 1,423 out of 6,000 loans sampled, and so it is highly relevant to the breach analysis.  I simply would not have found that BAC presented enough of a question of fact with respect to the term, especially when MBIA presented testimony by BAC itself that concluded that BAC's loans in question were not subject to a qualified appraiser.  Again, though, what might have been too hard for MBIA to show at summary judgment stage will be far easier at trial.

Settlement Bid/Ask 

The only fair reading of the summary judgment opinions is that while MBIA lost on timing, it won on the law, and the factual disputes found by Justice Bransten that justified a denial of summary judgment do not appear to be difficult for MBIA to prove at trial.  Indeed, MBIA now has a roadmap for the trial, and there are no impediments, in terms of questions of law, to keep MBIA from obtaining a full damage recovery at trial.

Indeed, MBIA's counsel should be banging on the doors of Justice Bransten's chambers in an effort to schedule a trial as soon as possible.  

But, given that MBIA Insurance's liquidity is evaporating and MBIA has disclosed that it doesn't expect MBIA Insurance to avoid being placed in rehabilitation absent a prior settlement of the litigation, one wonders whether either MBIA management or the New York Department of Financial Services (NYFS) would view it in their best interest to continue the litigation after MBIA Insurance places itself, or the NYDFS places MBIA Insurance, into rehabilitation.  If not, pre-rehabilitation settlement is their best option.

MBIA CEO Brown had this to say on MBIA's 2012 4th quarter earnings conference call:

"We will continue to be motivated to reach a negotiated settlement because of the potential disruption and loss of value that would be triggered by a regulatory proceeding against MBIA [Insurance]. In addition I believe that Bank of America will also be motivated to achieve a settlement in order to avoid having their CMBS claims substantially diluted and delayed. Settlements occur when the perceived economic values converge and there's substantial drivers we think should suggest such a convergence. However if that is wrong, both companies will be damaged as a consequence. Moreover as I've said in the past, we will not accept a non-economic settlement."

(MBIA investors will have the opportunity to listen in on MBIA's 2013 1st quarter earnings conference call on May 9 to compare notes.)

One may think that the convergence of the settlement bid/ask is in process, given that the summary judgment decisions show to BAC that the most likely outcome of the trial will be substantially adverse to BAC, while MBIA gets closer to a rehabilitation event involving MBIA Insurance that MBIA recognizes will be adverse to it.

In terms of what this narrowing of the bid/ask spread might look like, let me think aloud with you, dear reader. 

Hasn't the prospect of a MBIA Insurance rehabilitation put a practical lid on MBIA's expected net recovery?  Isn't the practical net recovery ceiling for MBIA in settlement sufficient funds from BAC, after commutation of BAC's cds policies, to repay the $1.65 billion secured loan from its municipal guaranty affiliate, National?  Even if MBIA wins at trial $5 billion in damages from BAC, after repaying the National secured loan, won't the rest of the damage award likely get soaked up by MBIA Insurance rehabilitation claimants who assert damages or accelerate claims that are insured by MBIA Insurance, such that there will be nothing substantial to trickle down to the residual interest of MBIA?

If this is right, doesn't it make sense for MBIA to agree to a $1.65 billion net of commutation payment from BAC, or perhaps something more than that to make sure that MBIA Insurance is financially stable until it obtains mbs recoveries from Credit Suisse and ResCapUnless MBIA is able to raise financing to tide MBIA Insurance over for a couple of years, which it doesn't seem willing to do at its current share price, does MBIA have a practical alternative?

On the other hand, given the fair reading of Justice Bransten's summary judgment opinions, doesn't it seem likely that BAC would see that it is in its best interest to hit that bid?

Wouldn't NYDFS superintendent Lawsky become a hero mediator by achieving this outcome, a stable MBIA Insurance, a litigation-free National able to get rated by rating agencies again and begin to write new municipal finance business, with no regulated companies in rehabilitation?

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, April 29, 2013

Endgame Settlement Considerations

Bank of America (BAC) last reported carrying its MBIA cds wraps at $1.3 billion.  One thing one might feel confident in asserting, given that MBIA appears to be preparing a voluntary rehabilitation for MBIA Insurance, is that MBIA will under no circumstances make any payments in respect of BAC's cmbs cds, except in connection with a global settlement and commutation.

If BAC chooses not to settle and MBIA Insurance files for a voluntary rehabilitation (something I suggested was a possible tactical objective for MBIA five months ago at http://mbibaclitigtion.blogspot.com/2012/11/thoughts-about-mbiabac-post-consent.html), then BAC's cds wraps would be in default and impaired, and BAC would likely have to write off its entire $1.3 billion investment position in these wraps.

This amounts to a sunk cost that BAC has in an MBIA settlement of $1.3 billion.  Put another way, BAC doesn't incur a dollar in out-of-pocket settlement expense unless and until the settlement with MBIA exceeds $1.3 billion.

BAC's direct potential exposure to MBIA is well in excess of $4 billion.  In addition, BAC has additional exposure to MBIA in the form of the potential damage to BAC an adverse successor liability decision in the MBIA case might have on the Article 77 hearing (additional Article 77 exposure).  How you might quantify this contingent additional Article 77 exposure is subject to dispute, but it is tangible and real.

Let's assume that MBIA is willing to settle its case for $3.3 billion, and commute BAC's cds at $1.3 billion.  This implies a net payment by BAC of $2 billion (the excess over the amount BAC receives back in commutation) would resolve BAC's direct exposure of over $4 billion to MBIA and the additional Article 77 exposure.

Of course, if BAC doesn't settle, BAC may eventually face a judgment of over $4 billion to MBIA Insurance in rehabilitation and, because National's loan to MBIA Insurance is secured, BAC may still receive little or nothing in respect of its cds wraps, even after such a major MBIA Insurance recovery.

Assuming that BAC would prefer to avoid a $1.3 billion charge in this quarter, and pay $2 billion (net) to avoid well over $4 billion in MBIA direct exposure and additional Article 77 exposure, one wonders what questions the BAC board of directors are likely to have for BAC management if BAC management doesn't see the settlement light at the end of this endgame.

Sunday, April 28, 2013

Time for MBIA To Get Resourceful (Again)

On Friday, April 26, The Wall Street Journal reported that MBIA hired Weil, Gothsal & Manges in order to seek to prevent the New York Department of Financial Services (NYDFS) from placing the securitization guaranty subsidiary, MBIA Insurance, into a rehabilitation proceeding.  See MBIA Hires Law Firm.

Of course, no law firm can prevent the NYDFS from exercising its discretion to commence a rehabilitation proceeding, notwithstanding Hollywood portrayals of "fix-it lawyers" such as Michael Clayton.  So what might explain this hire of a firm that has experience in transactional matters and reorganizations, including according to Weil's website, representing Syncora in its restructuring.

Typically, if one is not considering litigation, one hires a law firm to plan and execute a transaction.  In this case, one wonders whether MBIA might be planning for a rehabilitation of MBIA Insurance, but on its terms.

Suppose MBIA convinced NYDFS to approve the repayment (or set up a NYDFS-approved mechanism that devotes all future cash flow of MBIA Insurance, first, to the repayment) of National's $1.7 billion secured loan by MBIA Insurance, as a condition to commencing a voluntary proceeding of MBIA Insurance's rehabilitation.  After all, this was National's money, used to commute cds wraps in favor of Morgan Stanley, National's secured loan transaction was specifically approved by NYDFS, NYDFS has an interest in seeing National get repaid (especially after defending the transformation litigation for four years), and the loan's ranking among MBIA Insurance's claims would rank highest, given its secured status.

Why would NYDFS agree to this?  Perhaps, MBIA offered to throw something into the pot, such as transferring any residual interest it may have in MBIA Insurance to the NYDFS, for eventual payment into the New York Insurance Fund. Or something similar that works for both MBIA and NYDFS.

The bankruptcy jocks among you might respond that this is a preferential transfer to an affiliate, subject to recoupment under federal bankruptcy laws.  You would be right, except New York State insurance law applies to the rehabilitation, not federal bankruptcy law.

So, one could see a 3am phone call to Bank of America (BAC) where MBIA says that BAC has until 9am to commence settlement negotiations based upon a supplied term sheet, or else MBIA will commence a rehabilitation of MBIA Insurance after National has been repaid its secured loan, and under the circumstance where MBIA's fraud and representation and warranty breach lawsuit against BAC will be continued to the bitter end, because the NYDFS is the real party in interest now, and it is in it to win it.

Given that BAC has already been caught sleeping at the due diligence switch, see Thoughts About MBIA/BAC Post-Consent Solicitation, perhaps MBIA's law firm hire indicates that MBIA is about to get resourceful, again.

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, April 12, 2013

Did the New York Appellate Court Just Eliminate Bank of America's "Sole Remedy" Defense?

The recent New York Appellate Division, First Department (1st Department) decision affirming Justice Bransten's partial summary judgment decision in January 2012 in MBIA v Bank of America (BAC) on the (i) absence of liability causation, and (ii) holding that loans needs not be in default in order to be subject to put back, and reversing on the availability of rescissory damages, is a model of brevity.  However, it can be faulted simply on the notion that it is the duty of an appellate court to careful explain its reasoning, hopefully with citation to authority.

The 1st Department did none of that.  Consequently, counsel for MBIA and BAC have engaged in a series of letter writing to Justice Bransten seeking to elucidate the decision's delphic, even talmudic, meaning. See BAC's first letter, MBIA's first letter, BAC's second letter, and MBIA's second letter .

What's this all about?

The upshot is whether MBIA must seek to recover its damages only through loan repurchase by BAC, as MBIA's "sole remedy", or whether MBIA is able to seek compensatory damages for representation and warranty (R&W) breaches made by BAC in the insurance agreement without going though the repurchase protocol.

Why does this matter?

It may not.  If MBIA is left to pursue the repurchase protocol as a sole remedy, MBIA can clearly point out that BAC has breached its obligations to repurchase loans, and its 90 day cure period has long lapsed.  Judge Rakoff followed this line of reasoning in Assured Guaranty v Flagstar and awarded Assured Guaranty a damage award for substantially all of its losses.  See Rakoff's discussion about Assured Guaranty's recovery of damages at pps. 94-100 of Rakoff Opinion.

This recovery theory is a two step process, as Judge Rakoff made Assured Guaranty show, based upon the circumstances involved with the securitizations that it insured, that if Flagstar had made all of its loan repurchases as it was obligated to do, and deposited the repurchase proceeds in the trust, noteholders would have gotten their payments as scheduled and Assured Guaranty would not have had to make any insurance claims payments.

If MBIA is not limited to pursuing this repurchase avenue of recovery as a sole remedy, MBIA can simply recover damages for R&W breach of insurance agreement directly, without this second step analysis. As an additional matter, MBIA had been seeking rescissory damages for breach of insurance agreement, which is an even more direct theory of recovery, but the 1st Deparment held that rescissory damages were unavailable.

So what did the 1st Department say with respect to this sole remedy limitation in its decision holding rescissory damages unavailable?

BAC counsel in its letters states that the 1st Department did not address sole remedy, that the sole remedy limitation is still intact, and it even appends a subsequent decision by Justice Ramos holding that Assured Guranty in another case is limited to its sole remedy.  (BAC also goes on to argue that MBIA must prove an additional form of causation at the damages stage, where BAC will seek to reintroduce its argument that everything but its breaches, most prominently the financial crisis, caused MBIA's damges, an argument BAC can no longer assert at the liability phase of the case since the 1st Department held that no such causation showing for liability is required.  This is the same argument advanced by Flagstar that Judge Rakoff rejected with respect to Assured Guaranty's recovery of damages against Flagstar).

On the other hand, MBIA counsel states that in denying rescissory damages, the 1st Department rejected the sole remedy limitation, albeit without saying so explicitly.

Who is right?

To answer this, you have to read the decision carefully and try to interpret the basis of the 1st Department's decision.  In my view, the only fair reading of the 1st Department decision reveals that it rejected rescissory damages as a special theory of recovery under an insurance agreement because recovery was otherwise available to MBIA under the insurance law (Sections 3105 and 3106).  The 1st Department said that where an insurer can defeat recovery of payments under the insurance law, the extraordinary equitable remedy of rescission is not warranted.

Now, if the 1st Department had said that it was because MBIA could recover payments by pursuing loan repurchases (whether or not as a sole remedy) as provided by the contracts, then BAC would be able to argue that it defeated MBIA's claim for rescissory damages because MBIA's remedies were purely contractual (and BAC would argue that the contracts provide for repurchase as a sole remedy).  But the 1st Department did not say that it was the availability of a contractual remedy that made rescission unavailable.  It specifically stated that it was the availability of an adequate remedy under the insurance law that made rescission unavailable.

A second reason advanced by MBIA is the statement made by the 1st Department at the end of the decision:  "We have considered the parties' remaining arguments and find them unavailing."  What were BAC's arguments?

BAC's appellate brief  sets forth its loan repurchase as a sole remedy argument at the end (or "remaining" portion) of its brief.  See argument beginning at p. 51.  Isn't this what the 1st Department is referring to when it says that BAC's remaining arguments are "unavailing"?  How can it be otherwise?

Now, if the 1st Department had simply said that it was not necessary to address BAC's remaining arguments, because a remedy other than rescission was available under the insurance law, then it would be clear that the 1st Department had not passed on the merits of BAC's sole remedy argument.

But when the 1st Department specifically states that BAC's remaining arguments are "unavailing", it seems to me that you would be hard-pressed to claim that your argument with respect to sole remedy had not been considered and rejected by the 1st Department.

Although that is clearly not enough to stop 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, April 8, 2013

A Short Primer on Difference Between Liability and Remedies

The recent New York Appellate Division First Department decision affirming MBIA on liability (no loss causation showing required, and performing loans are subject to repurchase) but reversing on availability of a particular remedy, rescissory damages (see MBIA Wins Big in New York Appellate Court; Financial Press Lays Egg) created a great deal of confusion in the financial press and among many investors as to what exactly was the import of the decision.

Perfect time to engage on a short primer on the difference between establishing liability, on the one hand, and pursuing remedies by recovering damages, on the other hand.  You have to keep these elements of a plaintiff's case separate in order to appraise the status of the case.  A plaintiff needs to develop a theory of liability in the first instance.  If proved, then the plaintiff must seek a remedy by developing a theory of damages.  Here's a go at what the New York Appellate Division First Department giveth and taketh away from MBIA. Net, net, advantage MBIA.


In MBIA v. Bank of America (BAC), MBIA is seeking to prove BAC's liability for breach of representation and warranty (R&W) under each of contract law and insurance law.  These are two separate theories, and by proceeding under insurance law, MBIA believed it could obtain rescissory damages as a remedy.

The remedy available under contract law is spelled out in the governing contracts, specifying that the originator is obligated to repurchase loans that breach R&Ws.  Rescission is a different remedy, which essentially terminates the contract and seeks to restore the parties to their original positions.  This would put the plaintiff back in the position it would have been in if it hadn't entered into the transactions in the first place.  Rescission is a remedy explicitly permitted by insurance law, while it is an extraordinary remedy under contract law.  More about that later. Essentially, however, the proof of liability under insurance law and contract law is the same.

MBIA has asserted that BAC's liability under both insurance law and contract law can be established if MBIA proves that BAC breached its R&Ws in the governing documents and those breaches materially increased MBIA's risk of loss. Under each theory it is unnecessary to show further that MBIA's losses were caused by those R&W breaches.  In other words, MBIA asserts that the test for BAC liability is a Day 1 test, measured as of the closing date of the securitization, while BAC asserts that the test for its liability is whether MBIA can prove that the particular R&W breach actually caused a loan to go into default, as opposed to some other causal event, such as the financial crisis or the debtor's losing his job.

So, under MBIA's theory of liability, all that is required is that a breach of a R&W by BAC that materially increased MBIA's risk of loss.  Under BAC's theory of liability, MBIA must establish that there is a causal connection (loss causation) between the breach of a R&W and the default of the loan and any consequent loss incurred by MBIA.

This question as to whether loss causation must be established in order for BAC to be found liable is of huge importance in the case, because it would be impossible for MBIA to prove that any breach of R&W was the specific cause of MBIA's loss.  To repeat, this was a huge win for MBIA.  The recent New York Appellate Division First Department decision is the first instance of an appellate court in New York holding that no mbs loss causation is necessary in order to establish liability.  This decision is binding upon all justices in the Commercial Division of the NY Supreme Court, New York County, where most of the mbs fraud litigation is being conducted.  While BAC is entitled to seek an appeal of the First Department decision to the NY Court of Appeals, the highest New York court, that appeal would be granted only at the discretion of the NY Court of Appeals (and is unlikely to be granted since there is no contrary holding in any other department of the Appellate Division in New York).

Before this New York Appellate Division First Department decision, all prior holdings to the effect that a showing of loss causation was unnecessary, including that of Justice Bransten in the MBIA v BAC case, were from trial courts.  While these decisions might have persuasive power, they were not binding on other trial courts in New York County.  This First Department ruling is a huge adverse development with respect to the establishment of liability for BAC and all other investment banks and mbs originators with cases that are pending or may be brought in the Commercial Division of the Supreme Court, New York County.  Of course, a litigant in another case might seek to distinguish its mbs case from the facts of the New York Appellate Division First Department decision, but this would be extremely difficult, as all of these securitization R&W breach cases present identical questions of law and very similar factual patterns.

So, given this liability ruling on the absence of loss causation and the requirement that performing loans be repurchased if they breached R&Ws, it is clear that in the event MBIA meets its burden of proof in establishing breaches of R&Ws, MBIA can require BAC to repurchase every loan in the trusts it insured with respect to which BAC breached a R&W that materially increased MBIA's risk of loss, whether or not that loan is in default.

According to MBIA, this ruling with respect to liability means that, assuming MBIA carries its burden of proof,  BAC breached its R&Ws to MBIA with respect to at least $12.7 billion of loans.  See p. 19 of MBIA slide presentation on SJ motion for primary liability.  Now, given this state of play with respect to BAC's massive liability exposure, let's proceed to MBIA's potential remedies.


MBIA presented two separate theories of damages: (i) rescissory damages, and (ii) compensatory damages arising from BAC's breach of its obligation to repurchase loans with respect to which BAC breached R&Ws. [Update:  I have reviewed MBIA's letter to Justice Bransten regarding the Appellate Division First Department decision, filed soon after I first posted this blogpost.  It is clear that MBIA is asserting a third theory of damages, compensatory damages for breach of insurance contract.  It is not clear to me that this theory of compensatory damages differs from (ii) above in any important respect]

Rescissory damages is a one step remedy, while compensatory damages arising from breach of BAC's repurchase obligation is a two step remedy.  The greater simplicity of seeking rescissory damages over compensatory damages is one reason why MBIA sought rescissory damages.

In the case of rescissory damages, the court would find that BAC would be obligated to reimburse MBIA for all of its losses and expenses MBIA incurred in connection with the insured transactions, so as to place MBIA in the position it would have been in had MBIA not entered into the transactions.  This amount is approaching $5 billion according to MBIA, and would include all of its insurance payments and lawyers expenses.  This is a single step analysis.

In the case of compensatory damages, the court would find that BAC was obligated to repurchase all loans that MBIA put back to BAC for repurchase, with respect to which BAC breached a R&W, but irrespective of whether the breach caused any MBIA loss and whether the loan was in default.  MBIA has made a showing at the motion for summary judgment on primary liability that BAC breached this obligation to repurchase loans.  See pps. 100-103 of MBIA slide presentation on SJ motion for primary liability

So, as a first step, assuming that the court holds that BAC breached its obligation to repurchase loans properly put back by MBIA for repurchase, the court would proceed to a second step, a "what if" analysis to see what MBIA's recovery should be. In this second step, the court needs to determine whether if BAC had repurchased all loans properly put back and deposited the purchase price for these putback loans into the trusts, would MBIA have ever needed to make any insurance payments to noteholders.

If the answer is no, then MBIA would be entitled to full recovery for its damages (all insurance payments made plus, as provided by the governing documents, reimbursement of legal expenses)...in other words, the same recovery as MBIA would be entitled to in the case of rescissory damages.  To the extent that MBIA would still have had to make insurance payments even if BAC repurchased all properly putback loans, then that amount of hypothetical insurance payment would reduce MBIA's recovery from BAC.

An example of this "what if" compensatory damages analysis can be seen in Judge Rakoff's opinion in Assured Guaranty v. Flagstar bank.  In the damages portion of the opinion that begins on page 94, Judge Rakoff speaks to this two step process of determining compensatory damages:   

"Therefore, Assured is not entitled to direct payment of the amounts Flagstar should have paid for purchase...but rather to reimbursement of the claims it has paid to the bondholders to the extent that the amounts Flagstar should have paid into the Trust would be sufficient to cover Assured’s claim payments...Moving on to the calculation of damages, what Assured showed through Dr. Mason’s damages model was that Flagstar’s failure to repurchase those defaulted loans that had breached the representations and warranties directly and proximately caused Assured to improperly bear the burden of paying claims on the transactions. Dr. Mason testified that, had Flagstar repurchased the defective loans, Assured would have been reimbursed for all the claims paid to the bondholders."

In that case, Judge Rakoff reviewed the expert statistical testimony of Dr. Mason to find that, indeed, Assured Guaranty would have been able to avoid all of its insurance payments if Flagstar had not breached its repurchase obligation.

This two step analysis to prove compensatory damages has been referred to as "damage causation".  This is not to confuse damage causation with loss causation, discussed above, which is not required.  This is why you have to keep liability and remedies separate in your mind.  BAC cannot escape liability by a showing of causation.  But, going on to remedies, MBIA must still show that its damages would not have been incurred if BAC had done what was required of it with respect to its obligation to repurchase loans.

Also, it is important to keep in mind what a showing of damage causation entails.  This is simply a mathematical analysis using statistical sampling and extrapolation to the entire trust pool to determine, based upon the number of loans that contained breaches of R&Ws and the amount of the insurer's payment, whether the insurer would have made any insurance payments had the originator repurchased all breaching loans.

MBIA has apparently done this analysis and it is confident that its remedies will not be limited.  in a recent article soon after the First Department ruling, an MBIA spokesman said the ruling on damages “does not limit our ability to achieve or change our expectation of a full recovery of all our losses.”

So, it can be seen that among two viable alternative routes for MBIA to obtain full recovery of its losses, the two step process of pursuing compensatory damages remains in full force. 

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.

Tuesday, April 2, 2013

MBIA Wins Big in New York Appellate Court; Financial Press Lays Egg

In a huge win by MBIA with respect to Bank of America (BAC) liability, the New York Supreme Court, 1st Appellate Division, held that MBIA need not show that (i) there is a causal link between a breach of representation and warranty (R&W) by BAC with respect to a loan and a loss suffered by MBIA in connection with the loan's default, and (ii) a loan is nonperforming in order for BAC to be obligated to repurchase the loan if it breached a R&W with respect to that loan.

These are the twin pillars of liability that MBIA has been trying to establish in order to obligate BAC to repurchase all loans with respect to which BAC breached a R&W, irrespective of whether that R&W breach caused a loan to go into default (as opposed to some intervening event that caused default), and whether or not the loan is still performing.  See pps. 30-34 of the Court's opinions handed down today at NY 1st Department Appellate Court Opinions.

The financial press initially reported only that the appellate court reversed Justice Bransten on the availability of rescissory damages.  (One could only have been supplied a headline by someone, such as BAC, and not have read the opinion in order to have reported this holding as only a loss for MBIA.)  This is a method of recovering damages, and is unrelated to the big win that MBIA obtained on liability in the opinion. Millions of MBIA shares were traded at cascading prices before this misleading news report was corrected to focus on the more important liability portion of the holding.

What this reversal on rescissory damages means is that MBIA cannot ask Justice Bransten to place MBIA in the position it would have been in had it not written the insurance policies on the trusts.  Nonetheless, MBIA is still entitled to prove that BAC breached its obligation to repurchase loans that breached R&Ws, which entitles MBIA to establish that if BAC had not breached this repurchase obligation, MBIA would not have been required to make payments under its insurance policies.

This is the same showing that Assured Guaranty successfully made against Flagstar Bank in its trial before Judge Rakoff. So if you understand what it was Assured Guaranty was able to accomplish against Flagstar, you will understand why this holding remains a big win for MBIA.

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, April 1, 2013

Time for NYDFS's Lawsky to Slap Some Heads in MBIA v. Bank of America

The MBIA v. Bank of America (with its subsidiaries, BAC) litigation saga is coming to a head this spring for two reasons.  Each situation involves what may appear to be simply a two-party game of strategic negotiating behavior between BAC and MBIA.  However, each situation also involves the presence of an additional party that creates potential additional gains, as well as additional uncertainty, regarding any settlement outcome between BAC and MBIA.

First, it is expected that Justice Bransten will issue her opinions on motions for summary judgment on Countrywide's primary and BAC's successor liability with respect to MBIA's insurance fraud and mbs putback (fraud) case within the next two months.  While any settlement of this action also involves the commutation of commercial mbs cds that MBIA wrote in favor of BAC, this is still a two-party negotiation.

What makes this a three-party negotiation is the presence of the BAC Article 77 hearing seeking judicial approval of the reasonableness of BNYM's (Trustee) $8.5 billion settlement of mbs putback claims against BAC on behalf of institutional investors, which is not expected to commence until after Justice Bransten has issued her decisions on summary judgment.

For reasons discussed in Linsanity and the Bank of America Article 77 Settlement Valuation Experts, an adverse decision on BAC's successor liability would be the second of two unfavorable legal precedents for BAC (the first being causation) that has occurred during the interval between the date the Trustee entered into the settlement agreement and any actual performance of the transactions contemplated by that settlement.  The actual Trustee release of claims against BAC and $8.5 billion payment by BAC are expressly conditioned in the settlement agreement on court approval of these transactions in the Article 77.

The reasonableness of the $8.5 billion settlement with institutional investors is premised on, among other things, the absence of BAC's successor liability.  So a settlement by BAC of MBIA's fraud litigation would serve double-duty by not only eliminating MBIA's approximate $5 billion fraud claim, but also by increasing the likelihood that BAC would gain Article 77 approval of its $8.5 billion settlement with institutional investors.  See Bank of America Successor Liability, the Article 77 Case, and Settlement Game Theory.

Second, as MBIA recently disclosed in its annual report, MBIA doesn't expect MBIA Insurance, its securitization guaranty subsidiary, to have sufficient liquidity to remain a going concern for the entirety of 2013, absent a settlement of MBIA's fraud litigation against BAC.   If MBIA Insurance cannot pay its claims because of a liquidity shortage, the New York Department of Financial Services (NYDFS) will place MBIA Insurance in rehabilitation (equivalent to a bankruptcy proceeding, but conducted under New York state insurance law and supervised by the NYDFS).  MBIA expects the fraud litigation settlement to occur before any rehabilitation proceeding for MBIA Insurance commences because it is in the financial interest of both MBIA and BAC to reach such settlement prior to any rehabilitation.  Both MBIA and BAC would suffer an adverse economic result, as discussed below, if a rehabilitation proceeding for MBIA Insurance commences as compared to their settlement outcomes prior to any rehabilitation.

The presence of the NYDFS makes this a second three-party game of strategic negotiation.  The timing of any rehabilitation proceeding involving MBIA Insurance is entirely within the discretion of NYDFS as insurance regulator.  As well, the conduct of any such rehabilitation proceeding, such as whether (i) BAC's cds claims (which are not regulated by NYDFS) against MBIA Insurance will be subordinated to MBIA's outstanding insurance policies (which are regulated by NYDFS), and (ii) MBIA's fraud case against BAC, continued by MBIA Insurance in rehabilitation and under NYDFS supervision, will be pursued through trial and appeal or will be settled earlier, is all up to NYDFS acting within its broad grant of statutory discretion.

Because the effect of MBIA Insurance's potential rehabilitation transforms the BAC/MBIA settlement negotiation into another three party game that involves NYDFS, it is time for NYDFS's chief Lawsky to step up to the table and do his job to prevent an easily avoidable insurance rehabilitation.  Any rehabilitation proceeding will create easily avoided losses not only for BAC and MBIA, but also for the New York insurance market and insurance policy holders.  As an insurance regulator, Mr. Lawsky should have a keen interest in making sure that an easily-avoided rehabilitation does not occur so as to inflict potential losses on MBIA Insurance policy holders.

An analysis of possible pre- and post-MBIA Insurance rehabilitation settlement outcome scenarios for BAC and MBIA, and a possible game-plan for Mr. Lawsky to pursue, follows after the jump.