Friday, November 30, 2012

Are Bank of America's CMBS CDS Insurance Policies?

I have posted about a scenario whereby MBIA could place MBIA Insurance (Securitization Sub) in a voluntary rehabilitation in order to adopt a "full litigation mode" strategy here.

In this "full litigation mode" strategy, Securitization Sub in rehabilitation would "turn the tables" on Bank of America (BAC) and pursue its fraud claims against BAC to the bitter end in order to maximize its damage recovery, and cram BAC's cmbs credit default swaps (cds, which BAC carries on its balance sheet at $1.35 billion) into a subordinated position, entitled to payment as a general unsecured claim only after payment has been made on National's $1.6 billion loan to Securitization Sub and all other payments have been made on insurance policies issued by Securitization Sub.

The distinction between an insurance policy and a cds for purposes of payment by an insurance company in rehabilitation is that the former is regulated by the New York Department of Financial Serves (NYDFS) and the latter is not.  For example, the form of an insurance policy must be filed and approved by NYDFS under NY Insurance Law Section 2307(b) and the form of a cds contract need not.  In MBIA's most recent investor conference call, MBIA CEO Brown confirmed that MBIA's exposure to BAC was in the form of "derivatives" as opposed to insurance policies.

The relevance of this distinction for purposes of payment of BAC's cds by Securtization Sub in rehabilitation is that the rehabilitator would classify BAC's cds as subordinated class 6 general unsecured claims, payable only after all insurance policy claims (more senior class 2 claims) and Natonal's secured loan have been paid.

The best authority for this proposition is the recent decision, In the Matter of the Rehabilitation of FRONTIER INSURANCE COMPANYIndex No. 97-06. (Supreme Court of New York, Albany County, May 23, 2012) (Judge Richard M. Platkin). (STATE OF NEW YORK SUPREME COURT COUNTY OF ALBANY

In Frontier Insurance, Judge Platkin held that surety bonds should be treated as "insurance policies" for purposes of classification as a class 2 claim. However, his reasoning makes clear that surety bonds are treated as "insurance policies" precisely because NYDFS exercises regulatory authority over them.  NYDFS exercises no regulatory authority over cds.  (See e.g. State of New York Insurance Department Will Not Regulate Credit

Using Frontier Insurance as a precedent, MBIA would be able to argue convincingly that since NYDFS does not exercise regulatory oversight over BAC's cds, it would be proper for Securitization Sub in rehabilitation to defer payment on BAC's cds in what amounts to a cramdown of BAC's claim.

What does this mean for purposes of settlement discussion between MBIA and BAC?  As a commercial mediator, I have found that one of the biggest barriers to consensual settlement is disparity of resources and negotiating leverage between the parties. Up to now, BAC has clearly maintained the upper hand in any settlement negotiation because of its superior resources.  It seems to me that now, MBIA has turned the tables on BAC.

Now that MBIA has amended its note indentures to prevent a cross-default to Securitization Sub's rehabilitation, and assuming MBIA wins the Article 78, MBIA is able to negotiate from a position of equal strength, by posing as a credible threat its own "full litigation mode" strategy, in which BAC's former strength, its willingness and ability to go the distance with litigation, is effectively turned by MBIA against 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.

Wednesday, November 28, 2012

How Does Your BATNA Look Now, Bank of America?

I have recently posted about a mediator's perspective of the MBIA v. Bank of America (BAC) litigation here, as well as a possible strategy for MBIA to "mail the keys" to MBIA Insurance (Securitization Sub) here.  It occurs to me that it might be best to consider these posts together in an analysis of how BAC might view the value provided it by a negotiated settlement agreement, as compared to what BAC might consider to be the value of its "best alternative to a negotiated agreement" (BATNA).

The term, BATNA, was first introduced in the seminal Fisher and Ury text, "Getting to Yes."  They posited that whenever parties in conflict seek to negotiate a settlement, they will compare the value and benefits provided to the party by the settlement (settlement value) to the maximum value and benefits that may be obtained by the party by pursuing some strategy other than settlement (the party's BATNA).  Typically in a litigation context, this would involve continuing the litigation through to court resolution, or pursuing settlement at a later time thought to be more propitious for the party.

In my last mediator's perspective post, I provided a framework by which I thought both MBIA and BAC could obtain from settlement what they needed, although not necessarily all that they wanted.  In that post, just to give some concreteness to the discussion, I assigned a notional value to BAC of this settlement at a negative (that is, a net payment to MBIA) $2 billion.

Assuming that this settlement value is correct for the sake of analysis, BAC would compare this settlement value to the value of BAC's BATNA.  It is not difficult to assess how BAC views its BATNA; BAC has pursued a litigation strategy of dragging the proceedings out and litigating every issue in an effort to wear down and impoverish MBIA, thereby using its superior resources to force MBIA to accept what MBIA would consider to be an "uneconomic" settlement.

If BAC were to prevail in the Article 78 proceeding, or if a rehabilitation or insolvency proceeding of Securitization Sub would create a cross-default to MBIA's public debt, BAC's litigation posture and its ability to pursue its BATNA would be substantially strengthened, and BAC's threat to continue the litigation would create significant pain for MBIA.  So one might consider that if these options remained available to BAC, BAC would value its BATNA as substantially greater than settlement value (ie a lesser net payment to MBIA than $2 billion). 

However, it appears that BAC will lose the Article 78 (though we must wait for Justice Kapnick's decision to be sure), and MBIA eliminated the cross-default scenario with its recently completed note consent solicitation.

Now, let's consider how BAC might view its BATNA's value if MBIA suggests in a settlement negotiation that MBIA is prepared to "mail the keyes" of Securitization Sub to the New York Department of Financial Services, as discussed in this post.

First, it is important to distinguish between NYDFS liquidation and rehabilitation proceedings. When I refer to the "mail the keys" strategy, I am referring to a voluntary rehabilitation proceeding initiated under Section 7402(l) of the NY Insurance Law.  In order to understand what a voluntary rehabilitation of Securitization Sub would look like, this FAQ site on FGIC's website is a good place to start.  Essentially, the rehabilitator (NYDFS or its designee) would come up with a rehabilitation plan for Securitization Sub, much like a debtor-in-possession federal bankruptcy proceeding.

The rehabilitator of Securitization Sub would be charged with maximizing MBIA's recoveries in its fraud damages suits against BAC and other mbs issuers, and would have the power to classify claims (such as BAC's cds) and provide for the timing and payment of these claims in a manner that is fair to those claimants and in the best interest for the rehabilitation of Securitization Sub. In other words, the rehabilitator could marshall Securitization Sub's assets and defer payment on its claims in a manner that will give Securitization Sub-in-rehabilitation the staying power to carry on MBIA's litigation against BAC as long as necessary.

It should be plain to see that this could quickly become the realization of BAC's biggest nightmare: a turning-around-of-the-litigation-tables in which the rehabilitator determines that it is in the best interest of the rehabilitation if Securitization Sub pursues MBIA's litigation straight through to final decision and appeal, and that all Securitization Sub claimants would have to await payment until these litigation proceeds are realized and the rehabilitated Securitization Sub is able to make equitable payment to all claimants (including repayment of MBIA's $1.6 billion secured loan to Securitization Sub).

Just consider what this should do to BAC's calculation of the value of its BATNA?  If I were BAC at a settlement negotiation with MBIA and I heard that MBIA was threatening to commence a voluntary rehabilitation proceeding, I would consider this to be a credible threat.  Indeed, one might think that BAC has shown us that it recognizes this as a credible threat by publicly stating that any successful consummation of the MBIA consent solicitation would make a rehabilitation proceeding of Securitization Sub "more likely".  

In any "full litigation mode" rehabilitation plan pursued by NYDFS, one might consider that BAC's BATNA should be valued much less than its settlement value (ie resulting in a much greater net payment to MBIA).  Moreoever, any "full litigation mode" rehabilitation plan would also expose BAC to further damaging legal precedents for its other existing and potential litigations (see here and here).

So, how does your BATNA look now, 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, November 26, 2012

Thoughts About MBIA/BAC Post-Consent Solicitation

MBIA announced this morning that it had successfully completed its consent solicitation and that it had amended the indentures for all of its outstanding public debt, so that a rehabilitation proceeding involving MBIA Insurance (Securitization Sub) would not create a default under MBIA's public debt.

I have discussed a mail the keys to Securitization Sub scenario here, whereby MBIA can substantially improve its negotiating position, and substantially worsen Bank of America's (BAC) negotiating position, with regard to settling their fraud and Article 78 litigation by threatening to invite the New York Department of Financial Services (NYDFS) to take over Securitization Sub and place it into rehabilitation.

The only event that now needs to take place before MBIA can embark on the mail the keys scenario is for Justice Kapnick to render her decision in the Article 78 proceeding brought by BAC, and for that decision to be adverse to BAC.

Or does Justice Kapnick even have to announce her decision before MBIA mails the keys, after all?

Monday, November 19, 2012

A Mediator's Perspective on the MBIA v Bank of America Litigation---Part 3

I have discussed a mediator's perspective of settlement of the litigation between MBIA and Bank of America (with its affiliates, BAC) previously here and here. In this post, I want to consider a possible "mediator's move" that might break a possible logjam in the negotiation. (Of course, I have no "inside information" regarding the status of any settlement negotiations between MBIA and BAC, and the numbers I suggest below may be viewed by the parties as unacceptable.  However, I do believe that my mediator's view may have some applicability to establish the framework for any settlement negotiation of this litigation, and offer some insight into how a possible settlement might play out).

A "mediator's move" is an attempt by the mediator to reframe the settlement negotiation when discussion has solidified around party "positions" rather than "interests."

An interest is an objective to be achieved by the party in the negotiation. An interest can be achieved in many ways, and the art of mediation is to seek to promote each party's interest in a manner that infringes upon the other party's interest in the least possible manner.

A position is the particular proposal that the party adopts to achieve its interest.  When positions are denominated in dollars involving the payment by one party to another of a fixed amount, party offers and counteroffers typically involve a zero-sum game: each party's attempt to better its position by a dollar is viewed as an attempt to worsen the other party's position by a dollar.  It is hard to improve a party's dollar position without hurting the other party's dollar position.

When events giving rise to the controversy have all transpired and the parties are litigating over past actions and incurred damages, it can be difficult to achieve a mediator's move away from party positions denominated in dollars to party interests achieved in other ways.  But if part of the controversy revolves around future actions and contingencies, there may be an opening for a mediator's move that makes such contingency work in favor of settlement.  There may be such an opportunity in any settlement of MBIA v. BAC.

Thursday, November 15, 2012

Will MBIA Get Summary Judgment on Bank of America's Breach of Insurance Agreements?

While much of the focus concerning the litigation between MBIA v. Bank of America (with its affiliates, BAC) is currently diverted to the contest between MBIA's debt consent solicitation and BAC's debt tender offer, discussed here, the real drama to this David v. Goliath controversy is about to be played out in front of Justice Bransten on December 5, 2012.

At this hearing, MBIA will be seeking summary judgment that BAC breached its insurance agreements with MBIA, authorizing MBIA to obtain recissionary damages equal to all of the losses sustained by MBIA on its insured BAC mbs pools, plus interest at the statutory annual rate of 9%.  This amounts to approximately $5 billion in damages.

The debt consent solicitation/debt tender offer contest has many possible outcomes, but MBIA does possess a "checkmate" move at the end of the game.  The notes (2034 notes) that are the subject of the consent solicitation/tender offer contest are prepayable by MBIA at any time.  MBIA will need to make a private placement of at least $330 million of replacement notes (with registration rights) that have a cross-default provision to its liking in order to prepay the 2034 notes, and the prepayment will be costly to MBIA, but the point remains:  MBIA has a pathway to achieve what it wants, the elimination of all holding company debt that cross-defaults to its securitization insurance subsidiary debt.

So, now back to the litigation front.  It has not been easy to track the parties' arguments, both because of redactions within the briefing and seals of entire motion papers and exhibits, as well as the flurry of counsel activity as the motions for unsealing filings (argued today), primary liability (to be argued December 5, 2012) and successor liability (to be argued December 12, 2012) have approached. 

It makes sense, however, to focus on two motions for summary judgment in particular that are game-changers, possibly game-enders:  BAC's breach of insurance agreements (this post), and the BAC parent company liability for subsidiary Countrywide's liabilities (future post).

Tuesday, November 13, 2012

MBIA v Bank of America Litigation Goes Corporate (and Hostile)

Bank of America (BAC) has just launched a tender offer for approximately $329 million of MBIA notes due 2034.  The purpose of this solicitation is to frustrate MBIA's consent solicitation of holders of all public MBIA debt to amend their indentures to prevent a default by MBIA Insurance (Securitization Sub) from constituting a cross default under MBIA's public debt.

In other words, if MBIA is able to win the Article 78 proceeding (now sitting in Justice Kapnick's decisional lap for the past 5 months), MBIA could theoretically (and euphemistically) mail the keys to Securitiziation Sub to the New York Department of Financial Services (NYDFS).  NYDFS would put Securitiztion Sub in rehabilitation and likely (i) continue the fraud and putback litigation with respect to which MBIA is nearing trial against BAC, and (ii) create a payment plan outlining how claimants (such as BAC) would get paid as funds become available to Securitization Sub.  This "mail the keys" scenario creates substantial additional risk for BAC.

If MBIA were to do this after obtaining the necessary debt consents, MBIA, the holding company for Securitization Sub and National Finance (Public Finance Sub), would not be in default under its holding company debt and would continue to own and operate Public Finance Sub.  Financial commentators have stated that MBIA is worth over $20/share, taking into account only the value of Public Finance Sub.

This ability of MBIA to mail the Securitization Sub keys after a win in the Article 78 case would appear to be primarily a negotiating tactic.  MBIA would appear to be leaving meaningful value on the table at Securitization Sub by using this strategy, and it would still be at risk to receive back repayment of Public Finance Sub's secured $1.6 billion loan to Securitization Sub.  Of course, apart from MBIA's desires, the NYDFS could always come in and take over Securitization Sub under its insurance regulatory powers...although MBIA has stated in its most recent earnings call that MBIA's debt consent solicitation is not being undertaken in view of any sense that the NYDFS was about to do this.  So, in addition to negotiating tactics, MBIA is also seeking to preserve the company ex-Securitzation Sub in the event of an undesired NYDFS takeover by conducting its consent solicitation.

And so, BAC has replied with its own negotiating tactic, deciding to spend as much as $329 million (and at least $165 million to buy 50% of the notes under their early tender pricing) to deny MBIA from being able to employ its negotiating tactic.  Suddenly, the stakes involved in improving negotiation posture have been raised.

MBIA has several strategies available to counteract BAC's debt tender offer.  The $329 million 2034 notes that are the subject of BAC's tender offer can be prepaid at any time, at par plus the present value of future payments discounted at the current treasury rate of a comparable maturity plus 15 basis points (which, of course, is quite low and therefore this "make-whole" provision would be expensive).  So, MBIA could issue new notes in a private placement (having default provisions that would not be triggered by a Securitization Sub default) and redeem the 2034 notes even if BAC purchases them all.  This private placement can be closed in a week.  It will cost MBIA more than the debt cost for the 2034 notes, of course, but the point is that BAC's tender offer, if successful, does not prevent MBIA from pursuing its strategy.  It would just make it more costly.

MBIA could also go into the market and buy 2034 notes.  Any such notes bought by MBIA would not be deemed "outstanding" for purposes of its own debt consent solicitation, but it would lessen the amount of notes that would have to be bought by "friends of the family" in order to block the BAC tender offer strategy (and, of course, any 2034 notes MBIA bought in the market would lessen its prepayment cost).  As well, MBIA could conduct an exchange offer with holders of its 2034 notes, offering new notes without a cross default provision, and likely a higher interest rate and some cash, in exchange for the 2034 notes.

Finally, if indeed the consent solicitation is only a negotiating tactic and MBIA has multiple other paths to ensure sufficient liquidity at Securitization Sub to permit it to pursue its litigation with BAC to the end, MBIA could simply terminate its consent solicitation and pursue those other, likely more costly, strategies.  While terminating the consent solicitation may be difficult for MBIA to swallow, it would signal to the markets (and BAC) MBIA's belief that it is not exposed in the near and medium term to a NYDFS takeover of Securitization Sub.

Of course, MBA could also file a motion for a temporary restraining order (TRO) while it implements its corporate response strategy; while obtaining a TRO is not likely to be successful, seeking such a TRO would be considered good form in the world of hostile corporate transactions.

It now seems that the tail is wagging the dog, as if the decisionmakers at both MBIA and BAC are more interested in looking smart than astutely managing risk/reward. I am beginning to think that if Dickens were still writing, he would have a field day with all of this.

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.

Thursday, November 8, 2012

Is Bank of America's Article 77 $8.5 Billion Settlement Hostage to its Case with MBIA?

On June 28, 2011, Bank of America (together with its afilliates, BAC) entered into a settlement agreement (Settlement Agreement) with Bank of New York Mellon, the trustee (Trustee) of 530 mortgage-backed securitization trusts, under which the Trustee, on behalf of trust investors holding over $200 billion of mortgage-backed securities (mbs), agreed to release all fraud, breach of representation and warranty (R/W), and other claims (Released Claims) those mbs investors could assert against BAC for payment by BAC of $8.5 billion.

At the time this Settlement Agreement was entered into, these BAC mbs trusts had (i) already experienced losses in excess of $25 billion, (ii) losses on loans over 60 days delinquent that was projected to be an additional $50 billion, and (iii) further losses on loans in addition to these delinquent loans that was projected to be over $32 billion, aggregating a total amount of experienced and projected losses for these BAC mbs trusts equal to over $107 billion.

Interestingly, the Trustee and BAC could have simply closed the Settlement Agreement at the time of its execution during the summer 2011 by BAC's payment of money to the Trustee, and the Trustee's issuance of a release of the Released Claims to BAC.  While it was forseeable that the Settlement Agreement would have been challenged by some mbs investors who thought the $8.5 billion settlement amount was too low for the release of the Released Claims in connection with over $107 billion in expected losses, any such challenge would have been ajudicated on the merits based upon the reasonableness of the Trustee's consummation of these transactions under the Settlement Agreement in the summer of 2011.  Developments subsequent to a closing of the Settlement Agreement would not have affected the Trustee's reasonableness in releasing the Released Claims in exchange for receipt of $8.5 billion if those actions were closed and completed at that time.

Instead, the Trustee and BAC did something quite different.  They elected to postpone consummation of the transactions contemplated by the Settlement Agreement (the $8.5 billion payment and release of Release Claims) until a further condition was satisfied: obtaining judicial approval of the reasonableness of the Trustee's actions pursuant to an Article 77 action filed in the Commercial Division of the Supreme Court of New York.

Because the Settlement Agreement, by its terms, cannot be closed until Article 77 approval is obtained (or it is determined that it cannot be obtained, or the condition is waived), the transactions contemplated by the Settlement Agreement remain prospective with no legal effect unless and until such Article 77 approval is obtained.

There is a crucial distinction that must be kept in mind in connection with any analysis of the Trustee's reasonableness in an Article 77 proceeding: is the court in an Article 77 hearing determining the reasonableness of the Trustee in entering into the Settlement Agreement in the summer of 2011 (understanding that no payment was made and no claims released then), or is it determining the reasonableness of the Trustee's release of the Released Claims for payment of $8.5 billion when these actions are permitted to occur, under the Settlement Agreement?

The Settlement Agreement states:  "the terms of this Settlement Agreement are subject to and conditioned upon 'Final Court Approval' [judicial approval in an Article 77 proceeding that the Settlement Agreement expressly authorizes the Trustee to commence]...If at any time Final Court Approval of the Settlement shall become legally impossible (including by reason of the denial of Final Court Approval by a court with no possibility of further appeal or proceedings that could result in Final Court Approval), the Settlement Agreement shall be null and void and have no further effect as to the Parties...[except for provisions not relevant]" [emphasis added].

So, given that the Settlement Agreement is contingent and the transactions contemplated by the Settlement Agreement are prospective, the focus of the reasonableness of the Trustee in an Article 77 proceeding should be not whether it was reasonable for the Trustee to enter into the Settlement Agreement in the summer of 2011, but rather whether it is reasonable for the Trustee to perform the transactions...release the Released Claims for payment of $8.5 billion...only at such time those transactions are permitted to close and have legal effect.

Therefore, any inquiry into the reasonableness of the Trustee should remain an open question subject to legal developments post-summer 2011 until such time as the Settlement Agreement is enforceable against BAC and the Trustee...and that will only occur when Article 77 proceeding has been completed and a favorable decision rendered, such that the transactions contemplated by the Settlement Agreement can have legal effect and be consummated. 

The Article 77 schedule contemplates a hearing schedule that will last well into the spring of 2013 with a decsion by Justice Kapnick expected much later in 2013 (considering that Justice Kapnick has not yet issued her opinion in the BAC Article 78 hearing against MBIA and the NYDFS that concluded in June 2012).

So, this raises a fascinating question: what happens if the legal analysis that the Trustee obtained in the summer of 2011 that, in its view, supported the reasonableness of the transactions contemplated by the Settlement Agreement, is rendered stale or wrong by judicial holdings subsequent to the summer of 2011, such that at the time the Trustee seeks to obtain judicial approval to consummate the Settlement Agreement transactions (the only time the Trustee can enforce the Settlement Agreement against BAC), the Trustee's actions can no longer be fairly regarded as reasonable?

It so happens that this fascinating, and financially momentous to BAC, question is presented with full force in the MBIA v. BAC fraud and R/W litigation currently approaching trial before Justice Bransten in the same court as the Article 77 proceeding. Incredibly, it is BAC, itself, that is pursuing a strategy in the MBIA litigation that, given Justice Bransten's judicial decisions to date and motions that are expected to be argued just next month in this litigation, is creating judicial doubt as to the reasonableness of the Trustee's consummation of the Settlement Agreement with BAC.

I have stated in this blog before, here, that BAC's litigation strategy in the context of its legacy Countrywide mbs claims appears idiotic and self-defeating, by creating adverse judicial precedents in the MBIA proceeding that can be applied against BAC by the use of offensive collateral estoppel in much larger proceedings against it.  BAC's strategy to continue litigation with MBIA risks creating additional judicial precedents that effectively makes the Article 77 proceeding a hostage to BAC's MBIA litigation.  It must be kept in mind that through the assertion of offensive collateral estoppel, it is generally the case that any judicial finding of law and fact in the MBIA litigation adverse to BAC that is at issue in the Article 77 proceeding can be enforced against BAC by objecting mbs investors.

This appears to me to be just another example of breathtakingly stupid legal risk assessment by BAC's executives and board of directors.