By Alison Frankel
NEW YORK, May 11 (Reuters) – Of the 18 banks that challenged
bond insurer MBIA’s restructuring in 2009, only two —
Bank of America and Societe Generale —
remain. On Monday, unless there’s a last-minute settlement this
weekend, they will finally go to trial in New York State Supreme
Court to argue that state insurance regulators should not have
approved MBIA’s split, which stripped $5 billion in capital from
MBIA’s crippled structured-finance insurance business.
But exactly what shape the trial will take — and what
relief BofA and SocGen can ultimately obtain — remains unclear.
Bank lawyers from Sullivan & Cromwell, MBIA counsel from
Kasowitz Benson Torres & Friedman, and state lawyers from the
office of New York Attorney General Eric Schneiderman are all
preparing for a proceeding whose parameters have not been set.
The banks call it a trial and continue to insist they are
entitled to call expert witnesses such as former state insurance
officials, who would opine on the adequacy of former Insurance
Superintendent Eric Dinallo’s vetting of MBIA’s restructuring.
MBIA and the state say the proceeding, brought under an
expedited process known as Article 78, should be limited to a
few witnesses with direct knowledge of the regulatory
investigation. Justice Barbara Kapnick, who is overseeing the
case, has called the trial “a glorified oral argument, with some
testimony, the crucial testimony, to support it.”
Kapnick agreed at a hearing on April 20 to permit witness
testimony at the trial, but she didn’t specify who could be
called as a witness. Nor did she set firm rules
when she held a conference call this week with all of the
parties. So the first order of business Monday will almost
certainly be argument on motions to define the trial, though
it’s just as likely that the lawyers will end up fighting over
the witnesses one by one, as they are proposed. Kapnick has set
aside 16 trial days over four weeks for the proceeding.
MBIA has spent more than $1 billion to settle with the 16
other banks that were part of the original coalition challenging
its restructuring, including, most recently, Natixis,
UBS, Morgan Stanley, and Royal Bank of Scotland
. According to MBIA’s quarterly filing with the
Securities and Exchange Commission on May 10, it has shed tens
of billions of dollars of exposure through those deals. In just
the first five months of 2012, MBIA commuted $11.5 billion of
exposure.
But the insurer’s structured-finance arm, MBIA Insurance,
has had to borrow from its better-capitalized municipal bond
division, MBIA National, to fund those settlements. Last fall
MBIA Insurance took out a $1.1 billion secured loan from MBIA
National, at the time it announced a settlement with Morgan
Stanley. According to its May 10 filing, MBIA Insurance has
borrowed another $443 million from MBIA National in the last two
months.
MBIA’s balance sheet is also a complicating factor in any
global resolution of its disputes with Bank of America. These
include a fraud case that parallels the challenge to MBIA’s
restructuring, as well as MBIA’s claims against mortgage company
Countrywide Financial, which is now part of Bank of America.
MBIA claims Countrywide breached representations and warranties
on mortgage loans underlying securities insured by MBIA. MBIA,
as you surely know, has been in the vanguard of reps and
warranties litigation with MBS issuers, and its case against
Countrywide has broken important ground in what’s known as
put-back litigation. MBIA may well eventually prevail in the
case — as I’ve written many times, the judge overseeing the
suit, New York State Supreme Court Justice Eileen Bransten, has
sided with MBIA and against Countrywide and BofA on most of the
big questions she’s confronted so far. But MBIA hasn’t waited
for the final judgment to hatch before counting its put-back
chickens. Even though the Countrywide case is still in prolonged
discovery, MBIA has booked $3.2 billion of “expected
recoveries,” according to its May 10 filing.
Bank of America and MBIA, in other words, both believe the
other owes it enormous sums of money. MBIA wants Countrywide to
pay billions to resolve its put-back claims. BofA wants
corresponding billions to commute its MBIA credit default swaps
and structured-finance policies through a settlement in the
restructuring litigation. Global settlement talks promoted by
Benjamin Lawsky, the Superintendent of the New York Department
of Financial Services, have apparently foundered because Bank of
America has balked at the idea that its CDS claims are worth
fewer cents on the dollar than MBIA’s put-back claims against
Countrywide. BofA seems to be convinced that MBIA needs the
bank’s money more than BofA needs MBIA’s.
The bank could well be right. MBIA’s May 10 filing concedes
that the insurer “did not write a meaningful amount of U.S.
public finance insurance” in the first quarter of 2012, and does
not expect to write new muni-bond policies unless and until it
resolves the litigation challenging its restructuring. That
means MBIA doesn’t have a business future as long as the banks
keep litigating the propriety of its restructuring.
But BofA faces downside from the continued standoff with
MBIA as well. In the case before Bransten, MBIA is poised to
move for summary judgment on the bank’s liability for
Countrywide’s representations and warranties on deficient
mortgage loans. An adverse ruling for Bank of America in MBIA’s
put-back case could hurt prospects for court approval of BofA’s
proposed $8.5 billion global settlement with investors in
Countrywide mortgage-backed securities, since that deal is based
partly on the assumption investors won’t be able to establish
BofA’s successor liability for Countrywide mortgage-backed
securities. Moreover, as I’ve reported, the bank also runs the
risk of going to the back of the line of MBIA’s creditors if,
for any reason, the state decides to put the insurer into
receivership ().
Receivership is one possible outcome if Kapnick rules MBIA’s
restructuring was improperly approved. The Department of
Financial Services could decide that, in order to protect
municipal bond policyholders, it must put MBIA into the
insurance equivalent of Chapter 11. In the alternative, if the
banks win, the state could appeal, triggering an automatic stay
of Kapnick’s ruling.
The banks’ lead counsel, Robert Giuffra of Sullivan &
Cromwell, has said in open court that if the banks prevail in
the Article 78 proceeding over MBIA’s restructuring, MBIA can
just reapply for approval “in open daylight.” But that seems the
least likely result of the litigation, particularly with the
parallel fraud case brought by the banks against MBIA scheduled
for trial in 2013. Without a global settlement, it will take
years for these cases to run through the trial and appeals
process.
Hotly anticipated trials like the one starting Monday, at
least in the early days, are weirdly festive, like a big horse
race when the gate first opens. But it’s hard to see how either
side wins this case, regardless of the trial’s outcome.
