Last week, I wrote about a few developments that should boost RMBS litigation recoveries, especially for bond insurers – Judge Crotty’s summary judgment decision in Syncora v. EMC (JPMorgan) and Syncora’s subsequent settlement with BofA, resolving all of the parties’ ongoing relationships. It appears I’m not the only one who has concluded that banks may need to reassess their potential payouts as a result of recent legal setbacks.
In this July 27 client alert, major financial services firm O’Melveny & Myers, which represents BofA in MBIA’s putback suit in New York, addressed the impact of Crotty’s Opinion [hat tip Manal Mehta from Sunesis Capital for passing this along]. While the alert is short and worth reading in its entirety, the gist of O’Melveny’s conclusion is as follows:
In light of a recent federal court ruling, banks may wish to reevaluate litigation risk from plaintiff insurers claiming injury from alleged breaches of representations and warranties regarding mortgage securitization notes that they insured…
Institutions facing such lawsuits may wish to re-evaluate their exposure, and possibly adjust reserves set aside to cover such risks, based on the type of plaintiff and the specific language of the securitization agreements at issue.
Hold the phone – so BofA’s own law firm in its putback litigation with MBIA is publishing an alert saying that banks may need to adjust their loss reserves associated with monoline putback litigation? This is essentially an admission that the firm sees the tide turning against the banks in these suits. Shouldn’t this have generated some serious pushback from O’Melveny’s powerful client?
Short answer: yes. According to Mehta, this alert was pulled from O’Melveny’s website shortly after publication, only to be re-posted today. We can only speculate as to why the alert was pulled and then re-published (without significant revision), but I can imagine that there were a few heated phone calls in between.
Regardless, now that we finally have a definitive decision from a respected court on the proper standard for mortgage putbacks, we have enough guidance to begin discussing RMBS litigation end games in earnest. Today, we’ll begin by looking at the bond insurer suits.
These, along with mortgage insurer suits, were some of the earliest filed pieces of RMBS litigation and have been prosecuted aggressively since the onset of the mortgage crisis by some of the most skilled and aggressive private legal teams in the business. And for good reason: the monolines issued what are known as “financial guaranty” policies, which included a guarantee that insurers would make policy payments if losses mounted; they could not deny claims or rescind coverage.
This means that bond insurers have already suffered massive, company-crippling losses as a result of insuring pools of misrepresented loans, and have been forced to pursue years of contentious litigation just to try to recover the funds they paid out. The good news for them, is that after 4+ years of litigation, they’re finally beginning to see the light at the end of the tunnel.
Monoline End Game Scenarios
As I mentioned at the top of this article, Syncora and Countrywide just reached a settlement of all their outstanding RMBS litigation and other issues, in which Syncora will receive a cash payment of $375 million and a return of certain of its preferred shares, surplus notes and other securities. It’s no coincidence that this settlement comes on the heels of several wins for the monolines in their suits against the major Wall St. banks. It demonstrates that the banks (or at least Bank of America), are beginning to realize that the bond insurers’ claims in these suits are potentially expensive and difficult to defeat. This settlement, in conjunction with BofA’s settlement with Assured Guaranty (AGO) back in April of 2011 and its proposed settlement of investor putback claims initiated in June 2011, show that BofA is making a concerted effort to put legacy Countrywide liabilities behind it.
This bolsters my long-held view that the most likely end game scenario for the monolines consists of party-by-party settlements with their various bank counterparties that address all of the outstanding legal issues between the parties. As I’ve discussed in the past, the last thing that an issuing bank wants is for one of these cases to go to trial and to see the parade of horribles that the monoline will trot out before the factfinder, showing clear breaches of underwriting guidelines time and time again. Not only would such a trial be long and embarrassing, but it would open up the banks to paying upwards of 75-80 cents on the dollar of losses to the insurers, rather than the 25-30 cents they might be able to pay in settlement.
Of course, the tougher questions surround the timing and the ultimate size of these potential settlements. If we could get our arms around the size of prior settlements, this might help give us a ballpark of the size of the settlements to come. In my prior article on the Assured Guaranty settlement (at item No. 4), I noted that based on BofA’s estimates, they were covering about 55% of AGO’s losses. The Syncora-Countrywide settlement is much more difficult to parse as the deal, according to Syncora’s press release was part of “an effort to terminate other relationships between the parties,” aside from simply the putback disputes. My guess is that the putback disputes constituted the bulk of the outstanding liabilities, but it’s difficult to assess the exact proportion, as well as the value of the other consideration received by Syncora.
What we do know is that in the five deals that were the subject of Syncora’s lawsuit against Countrywide, Syncora had already paid out $145 million in claims to policyholders and had received another $257 million in claims as of the filing of the Amended Complaint. That’s $402 million in existing claims, and future losses and claims in those deals could drive that number even higher. Plus, the settlement covered nine other MBS Trusts not at issue in the lawsuit. Barclays projected out the lifetime losses for Syncora in those trusts and reached a figure of up to $1.4 billion (though I know it’s hard to trust anything Barclays says since the emergence of the LIBOR scandal, other commentators have checked Barclay’s work, and it appears to hold up). Assuming this is a reasonable estimate, and putting aside the value of the other consideration given to Syncora and the value of the non-RMBS liabilities it released, the $375 million cash payment works out to about 27 cents on the dollar of claims.
So what does this mean other monolines, such as MBIA, might receive in settlement? In my opinion, Syncora’s settlement with Countrywide merely sets a floor for MBIA’s case against Countrywide – that is, it is the minimum amount per dollar of claims that MBIA can expect to receive from settling that case. This is because MBIA is in a better position in many respects than Syncora.
For one, while Syncora claimed to have found approximately 75% of the loans it had reviewed to be in material breach of Countrywide’s reps and warranties, MBIA has alleged that over 90% of the loans in the deals it insured were materially defective. A higher breach rate means a potentially higher judgment per dollar of claims should the putback claims go to trial, driving settlement values higher. The fact that MBIA has actually sued on all of its Countrywide transactions, whereas Syncora only sued on 5 of 14, implies that MBIA’s deals may have been worse across the board, further elevating settlement projections.
MBIA is also further along in its case against Countrywide/BofA than Syncora was, having conducted significant potentially damaging discovery on issues such as Countrywide’s internal fraud reporting and successor liability. MBIA is on track to present its summary judgment motion on Countrywide’s liability (referred to as “primary” liability) on August 31, and its summary judgment motion on BofA’s liability (referred to as “successor” liability) on September 21. BofA is keen to avoid even the presentation of such motions by MBIA because they will publicly disclose (to the extent the information is not treated as “confidential” and sealed) all facts that MBIA has uncovered in support of its positions.
This is especially true with respect to MBIA’s motion on successor liability, as the facts MBIA will use to establish that BofA should be on the hook for Countrywide’s liabilities could be used by any plaintiff suing Countrywide and wishing to bring BofA into the case as a guarantor. That is, the facts supporting successor liability in MBIA’s case will be directly applicable to every other plaintiff’s case for successor liability against BofA. Apparently recognizing this, just this week MBIA asked the Court for permission to file a motion lifting the confidentiality restrictions on certain documents received in discovery. MBIA’s attorneys know that the threat of public disclosure of items like Brian Moynihan’s deposition transcript may be the best leverage they have to force BofA to the negotiating table.
Finally, MBIA has filed a fraud claim against BofA that is fairly well developed. This claim has survived a motion to dismiss (and appeal of that decision) and a motion for partial summary judgment on loss causation. Should that claim be successful, MBIA could receive compensatory damages for the full amount it has lost in connection with insuring the Countrywide trusts at issue (not tied to any breach rate of the underlying loans) plus punitive damages of up to several times compensatory damages. Though punitives are rarely awarded, the treat of punitives will certainly increase MBIA’s settlement leverage (and what better case for the imposition of punitive damages if Countrywide is shown, as MBIA suggests, to have been engaged in the systematic encouragement and coverup of mortgage fraud?).
All this leads me to believe that MBIA will be able to force BofA into a much larger settlement per dollar of claims than the one Syncora received (the same goes for Ambac in its case against EMC/JPMorgan, as it has uncovered significant evidence of a fraudulent “double-dipping” scheme in that case). Of course, MBIA also has to contend with BofA’s litigation counterweight, in the form of its Article 78 and plenary actions challenging MBIA’s Transformation. But as the Article 78 decision seems likely to go against BofA (and will be appealed, regardless), and the plenary action is falling way behind the putback action due to inactivity during the last several months, MBIA will likely feel as though it has all the leverage when it comes time to seriously talk settlement.
According to MBIA’s first quarter 10-Q, the bond insurer has incurred $4.8 billion of losses on its portfolio of insured first- and second-lien RMBS deals. The monoline has also booked $3.2 billion in expected recoveries from putbacks (it has booked no expected recoveries from its non-contractual claims). That works out to a 66.7% expected recovery rate per dollar of incurred losses. This would be higher than the global settlements Syncora and AGO struck with BofA, but given MBIA’s superior position, at least in its BofA case as discussed herein, I can’t say those estimates are unreasonable.
In fact, I think MBIA would recover a much higher percentage of its losses should it proceed to trial against counterparties like BofA. The insurer could recover compensatory damages at 100% of losses if it wins its claims for fraud or rescissory damages, and damages in the range of 75% of losses if it’s forced to go the putback route, as my experience in these types of cases leads me to believe that at least 80% of MBIA’s alleged ineligible loans to be upheld by the factfinder. Compared to these end game scenarios, a settlement in the 66% range may begin to look attractive as MBIA continues to pile up victories in its litigation.
This brings me to probably the tougher question on monoline end games – timing. Settlement timing is always difficult to estimate since so many factors are at play. But there are certain points in litigation that I term “inflection points” – junctures at which settlement becomes more likely because of the threat of adverse legal developments. The presentation of MBIA’s summary judgment motions in its case against Countrywide/BofA (especially the one on successor liability) create just these sorts of inflection points. The time between when the summary judgment motions are fully briefed and Judge Bransten issues her rulings also constitutes an inflection point, as BofA may feel pressure to avoid yet another scathing Bransten decision. Based on these upcoming inflection points in the case, I will go out on a limb and say that MBIA’s litigation against BofA is likely to settle before the end of this year.
This timing will be different for each monoline action depending on the individual circumstances, but what they all have in common is that they all are very likely to settle before trial. Given the lack of viable defenses that banks have at their disposal, and the parade of damaging evidence that will paraded before a factfinder should trial ensue, I don’t see how any financial institution can logically allow any of these cases to go to trial. Doing so would only expose the banks to potentially devastating precedent and damage awards, which they call ill afford at this time.
There are important differences between the monoline cases and the cases of RMBS investors, the other major group of plaintiffs attempting to recover their losses from the major banks. Stay tuned over the next week as I tackle those differences and the status of investor recovery efforts in my next installment in my series on end game scenarios.