Saturday, June 29, 2013

Ambac v Bank of America Schedule

I have posted that Ambac is the principal remaining beneficiary of Justice Bransten's summary judgment opinions in MBIA v Bank of America (BAC) at Ambac Is Using MBIA's Roadmap in Its Over $1 Billion Representation and Warranty Case Against Bank of America.  Like MBIA's case, Ambac's case against BAC is for damages exceeding $1 billion dollars.  

Ambac will be alleging the exact same facts as MBIA did in its argument for BAC successor liability, and much the same facts regarding Countrywide's origination process and representation and warranty (R&W) breach rate regarding mbs loans in its insured pools.  So being able to read and react to Justice Bransten's opinions in what amounts to a free dress rehearsal is mastercard-like priceless.

The court has just posted the agreed schedule for the case which shows that arguments for summary judgment are scheduled for early 2015, with decisions rendered on those motions presumably coming sometime during the summer of 2015.  The trial date would depend on whether there are appeals of the summary judgment decisions, and whether Justice Bransten stays the trial pending any such appeals.

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: no positions in Ambac or BAC.  Follow me on twitter.

Friday, June 28, 2013

The ResCap Bankruptcy, Bank of America Article 77, and the Death of Competence of Wall Street

The ResCap bankruptcy case and the Bank of America (BAC) Article 77 proceeding involve companies with many similarities, so it is striking to see how different are the two different judicial processes in efficiently and fairly resolving the cases.

ResCap and Countrywide are both insolvent mbs originators subject to a multiplicity of legal claims arising from the financial crisis.  They have solvent parent holding companies each of which conducted transactions with the subsidiaries which give rise to claims that the parent company should have successor liability for the subsidiaries' liabilities.

There is one major difference, however.  ResCap's bankruptcy case is proceeding in an open and fair manner with a full investigation into all of the relevant facts necessary to adjudicate the claims, and reach a settlement in connection therewith.  BAC's Article 77 proceeding, by contrast, is the concluding act to a mockery of a process that, if the BAC/BNYM settlement is upheld, presages the death of competence on Wall Street.

What do I mean by this?  It has been reported that Justice Kapnick, the presiding judge of the Article 77 proceeding, herself has stated in open court that "everything is backwards" in the Article 77 proceeding.  When you compare the bankruptcy proceeding to the Article 77, in particular with respect to the extent the facts of the dispute have been investigated before a settlement was reached, as well as the inclusiveness of the process, you will see why this is so true.

In the ResCap bankruptcy, there was a thorough investigation of the facts underlying the claims and transactions at issue in the case.  This was performed not only by the parties, but also by an examiner appointed by the bankruptcy judge, who shared his materials with the debtor and creditors committees as he was conducting the investigation.  While his final report was not unsealed while the debtor and the creditors committees were negotiating the plan support agreement, it is safe to conclude that the parties profited from the fruits of this investigation and, because of this investigation, the debtor and creditors had all of the facts at their disposal necessary to negotiate their settlement in an intelligent manner.

As well, when it came time to negotiate a deal with the debtor and the contribution its parent would make to the bankruptcy estate, all of the unsecured creditors were included in a committee, and each had the benefit of representation of counsel for the entire committee.  The negotiation also had the benefit of a mediator, a sitting federal bankruptcy judge, who was able to encourage settlement.

So in the ResCap bankruptcy, the facts were obtained before the negotiation, and the negotiation was conducted by all of the creditors sitting at the table represented by impartial counsel who represented all of the creditor committee members.

This is a competent process designed to result in a competent result, because all of the work that needed to be done before a settlement decision was reached had, in fact, been done.

As for the Article 77, as Justice Kapnick puts it, everything is bakwards.

BAC and the settling investors negotiated a settlement without knowing the important facts.  Which facts?  The extent to which the loan files sitting in the custody of BNYM, as trustee, complied with representations and warranties made about them in the transaction documents!  The parties were speculating about breach rates, and the trustee's financial advisor accepted BAC's speculation of breach rate, all in complete ignorance of what the actual breach rate was.  This actual breach rate could have been determined by a re-underwriting of the loan files.  Why did the trustee maintain the loan files? For precisely this sort of eventuality!  Can you imagine a bankruptcy judge endorsing the fairness of a case in which the parties had ready access to the facts but declined to investigate them?

Moreover, the negotiation between BAC and the settling investors did not involve a group of creditors that represented all creditors with an interest in the matter, and no effort was made by the trustee to try to include them.  The settling investors and its counsel expressly disclaim any inference that they were acting on behalf of the creditor group as a whole.

In fact, BAC was able to argue that Countrywide's bankruptcy would result in no recovery for creditors because there would be no successor liability for BAC, the creditors would have to show that the representation and warranty breaches directly caused the creditors' losses, and that sampling of loans and extrapolation to the entire pool would not be permitted, all of which were highly debatable claims by BAC which were given far too much credence by the settling investors precisely because the settling investors had failed to do their homework and had not conducted a thorough investigation before settlement discussions (unlike the case in ResCap).

Moreover, the settling investors were represented by counsel not qualified to practice New York law, which would apply to any litigation of the dispute (Ms. Patrick is a Texas lawyer), and who was not independent (Ms. Patrick's firm will receive a success fee equal to 1% of the settlement paid by BAC, but only if the settlement is upheld in the Article 77; indeed, Ms. Patrick's firm is more a party with an economic interest in the outcome of the proceeding than counsel representing creditors, much less all of the creditors whose interests are being adjudicated).

My point is not that the settling investors are not sophisticated financial institutions, nor that Ms. Patrick is not an able litigator or negotiator.  It is simply the point that the settling investors did not avail themselves of a process by which they could complete a full and fair investigation of the relevant facts before they commenced negotiations, a process also that would fairly include all creditors with an interest in a settlement that purports to bind all creditors...and now, the settling investors seek judicial approval over this failed process.

Instead, the settling investors were bullied by bluffing threats made by BAC that betrayed the settling investors' lack of knowledge of the relevant facts, for failure to have conducted a prior investigation.  To the BAC reported threat that it would put Countrywide in bankruptcy (which apparently moved the settling investors off their initial settlement bid in a hurry), the settling investors should have said, "go ahead make our day"...then, you would have had a bankruptcy process adjudicate the BAC/Countrywide matter in a way that would have resembled the ResCap/Ally matter.  Based on the ResCap/Ally bankruptcy result and Justice Bransten's holding that New York law applies to BAC's successor liability, want to place a bet on whether this would have resulted in a higher settlement award payable by BAC?

Indeed, putting Countrywide into bankruptcy was the last thing BAC would have wanted, as it would have effectively consolidated all of the investor and monoline mbs cases against it and Countrywide into one proceeding where the adversaries' costs of that proceeding would have been borne by the bankrupt estate. This would have eliminated BAC's legal strategy of economic attrition against the monolines. A completely idle threat!

The distressing thing to me about the Article 77 proceeding is what it implies as to the future of competence on Wall Street.  While Justice Kapnick is a very able judge, she has not practiced a day of commercial law in her life, and simply knowing what the law says about a trustee's duties, in general terms, is no substitute for having practiced on Wall Street where, at one time, competence mattered.  Really, competence is on trial in the Article 77, as well as the interests of the intervening investors.

So, now it is reported that Justice Kapnick has requested that the parties submit the Article 77 matter to mediation, a request that BAC refused.  It seems that BAC has found itself a process by which competence is not a prerequisite to approval, and it is intent on sticking with it.

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.

Tuesday, June 18, 2013

An Open Letter to MBIA Management. Start Spinoff Preparations Now

Now that the transformation litigation, challenging the separation of the municipal finance guaranty business of National from the securitization guaranty business of MBIA Insurance Corp, has been dismissed, it is time for MBIA to take the next step:  spinoff either National or MBIA Insurance to complete the structural separation of their separate businesses, and forever separate their disparate risk profiles and respective shareholder bases.

The investment merit of a spinoff at MBIA is obvious and recognized by MBIA management.  Recently, MBIA CFO Chuck Chaplin stated in an interview with BTIG analyst Mark Palmer that he appreciated the thinking of those who argue that the natural owners of National and MBIA Insurance Corp. over the long run may be different types of investors.  “I’m open to that argument,” he said. “When you have two businesses with very different risk and payoff profiles, the way to maximize value may be through a spin, or tracking shares, or other permutations. “It’s too early to say that is the case, but I could see it happening.”

Agreed.  But then, Mr. Chaplin said something that strikes me as dead wrong:  “At this point we think that the value of National can be maximized without separating it from MBIA Inc.,” he said.  As for the spinoff, Mr. Chaplin said that "it’s not something that we’re contemplating at this time."

This seems dead wrong to me for at least three reasons.

First, from an investor's standpoint, it seems clear that the intrinsic valuation of National is being punished by its corporate association with MBIA Insurance.  In my view, one can easily make the case that the standalone valuation of National is $16 per share, and I would assign a $2 per share valuation to MBIA Insurance (especially given that MBIA Insurance expects to receive approximately $4 per share by the end of the year in respect of its claims in the ResCap bankruptcy.  Remember, the inter-company loan to National as been paid off; the entire ResCap recovery stays at MBIA Insurance).

The reality is that the market is applying a negative valuation to MBIA Insurance, assigning about a $2 discount to National, because an investor in National must also be an investor in MBIA Insurance.

If you think about it, this is not an unreasonable investment position for an investor interested in National.  Most investors with an interest in municipal guaranty insurance have developed a well-deserved antipathy to securitization guaranty insurance, given the financial crisis events of the past five years.  Why should an investor in municipal finance necessarily make a bet on the prospects of a continued housing recovery, which is an important valuation criterion relating to MBIA Insurance?  MBIA is forcing this bet on a National-centric investor, and for this the National-centric investor is extracting a discount.

Second, the valuation of National is directly related to the creditworthiness rating assigned to National by the rating agencies, and Moody's has already gone on record as saying that it views MBIA's common ownership of National and MBIA Insurance as a negative for National's rating.  Moody’s analysts Helen Remeza and Stanislas Royer explained that “while National’s insured portfolio is expected to generate losses that are well covered by its claims paying resources, its business position is characterized by a lack of participation in the market for the last five years, and by its continued affiliation with the much weaker MBIA Corp.”

As National eventually starts to write municipal guaranty insurance again, the first concern expressed by Moody's will be addressed over time.  But this second Moody's concern, continued affiliation with MBIA Insurance, can only be addressed by MBIA management proactively by means of a spinoff and, for the reasons I set forth below, preparations for such a spinoff should start now.

So, irrespective of whether you think National should be tainted from a ratings point of view by being a sister affiliate of MBIA Insurance, it is hard to reconcile this ratings agency mindset with Mr. Chaplin's view that National's value is maximized by maintaining the current corporate structure.

Third, the remaining mbs representation and warranty (R/W) recoveries that MBIA Insurance can expect to recover will have a far greater positive valuation effect upon an isolated MBIA Insurance than upon the current MBIA capital structure.  This is true not only because the recoveries will represent a much larger percentage of the enterprise valuation of MBIA Insurance on a standalone basis, but also because the shareholder base of a standalone MBIA Insurance will be better able to assess the litigation valuation prospects of these R/W actions than an MBIA shareholder base that comprises primarily municipal finance investors.

I strongly believe that the lackluster performance of MBIA's stock price since the Bank of America (BAC) settlement illustrates the dysfunction of MBIA's continuing with a mixed shareholder base of National-centric as well as MBIA Insurance-centric investors. Selling in MBIA shares has likely been done by investors who were willing to become shareholders of MBIA to participate in an MBIA Insurance victory against BAC, but not willing to remain investors in the combined MBIA Insurance/National enterprise post settlement.  Put another way, I might believe that given the magnitude of MBIA's claims in the BAC litigation, I am willing to be an MBIA investor to participate in an MBIA Insurance litigation payoff before the BAC settlement, but the future prospects of MBIA Insurance in respect of the remaining R/W actions, in particular, and in the potential continuing housing recovery, in general, are not sufficient for me to be diluted as an investor in National as well. Certainly, Fairholme's selling of over 40 million MBIA shares post BAC settlement illustrates this notion.

Separating MBIA Insurance will not only improve National's valuation, but it may presage a resumption by MBIA Insurance of its securitization financial guaranty business.  One can expect that securitization transactions will reemerge over time, as the need is too great given the supply of commercial and residential real estate loans and the investment demand for yield.  One can see that transactions such as the one recently announced by Shellpoint Partners, which do not involve a sunset of R/Ws and in which the originator maintains an investment position in the pool, may become a template for not only a resuscitated securitization market, but also one in which guaranty insurance can reappear.  What will be good for National in isolating its shareholder base may also become good for MBIA Insurance.  If MBIA Insurance requires additional capital in order to resume its business, common ownership with National will only lead to further discounts to National's valuation.

Spinoffs are complicated transactions that require substantial lead time.  The to do list is long, and the transaction needs to conducted with care. 
  • Financial and legal advisors must be retained to analyze and propose the best structure and transaction pathway. 
  • The New York Department of Financial Services (NYDFS) will have to approve the transaction, and any NYDFS comments may require structuring and financial adjustment.  
  • MBIA may need to conduct a refinancing of its holding company debt in connection with a spinoff.  
  • The tax-free characterization of the transaction needs to be nailed down, and a private letter ruling from the IRS likely needs to be obtained.
  • Proxy statements and solicitations need to be filed and conducted.
  • A road show addressing the merits of the spinoff needs to be conducted by MBIA management.
 I have great respect for MBIA management.  But now it is time for MBIA management to get on the stick and start preparations for a spinoff.

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.

Sunday, June 16, 2013

I Have a Cup of Coffee with The Motley Fool

I had a conversation with The Motley Fool.  See here.

Not much new (I always keep the good stuff for this blog).

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; AMBC.  Follow me on twitter.