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.

Generally, there are two litigations to settle in MBIA v. BAC: MBIA's fraud mbs action (with related actions) and BAC's Article 78 proceeding challenging MBIA's transformation transactions approved by the NY Department of Financial Services.  This settlement negotiation likely involves an attempt by the parties to determine two payment amounts: how much BAC will pay MBIA to settle the fraud action, and how much MBIA will pay BAC to commute its insurance of BAC's cmbs.  Moreover even once the Article 78 proceeding is decided, resolution of the cmbs commutation amount will be part of the process to settle the mbs fraud settlement amount, given that the same two parties are involved in each payment negotiation.

MBIA has already incurred over $4 billion of losses that are the subject of the fraud mbs action (some further future losses are anticipated, but the significant bulk of the damages have already been incurred). On the other hand, MBIA's exposure on BAC's cmbs is prospective, and depends upon future events (such as the health of the commercial real estate market) and future actions (including by the servicer for the mortgages comprising BAC's cmbs).

The notion that any damages are prospective in the cmbs leg of this settlement may offer the opportunity for a mediator to construct a settlement proposal that moves beyond a zero-sum game of dollar denominated offers and counteroffers of cmbs insurance commutation prices.

Assume for a moment that MBIA was willing to settle the fraud mbs action for an amount in excess of its receivable that it has booked for this action, but at a reasonable discount to its anticipated potential damage award.  Let's assume that this amount is $3.5 billion.  Let's also assume that BAC would be willing to accept commutation of its cmbs insurance at an amount equal to its carrying value for this asset.  Let's assume this amount is $1.5 billion.

A final consideration involved in this situation is the extent to which MBIA "should" be willing to absorb market risk with respect to any settlement proposal.  In the case of MBIA's fraud action, MBIA is claiming breaches by BAC with respect to representations and warranties (R/W) concerning many small residential loans.  In the case of the commutation of insurance for BAC's cmbs, there are no allegations by MBIA of BAC R/W breaches, and the loans insured were much larger and susceptible of individual analysis by MBIA. So, if MBIA is to undertake any future exposure in any settlement, it is clear that it would be more acceptable in the case of the commercial mbs.

A possible mediator's move in this circumstance would be to propose that BAC pay $3.5 billion to MBIA in settlement of the fraud mbs action, and that MBIA collateralize its insurance of BAC's cmbs with $1.5 billion.

In this way, MBIA would receive payment for its fraud mbs receivable in excess of its carrying cost, and BAC would be made secure that it will receive not receive less than the amount it has booked for its cmbs asset.

This proposal would relieve the parties of the requirement that they come up with a mutually acceptable price for the commutation of MBIA's insurance of BAC's cmbs.  It would establish a floor for the recovery by BAC that would be no worse than its carrying value, precluding the requirement that BAC absorb a loss on its asset that is the subject of the settlement.  It offers MBIA the possibility that less than $1.5 billion in insurance will be paid out to BAC...and also the possibility that more will be paid out, but under circumstances where MBIA can't claim that BAC breached any R/Ws in respect of the cmbs.

Each party would walk away from this settlement likely receiving less than they would want, but certain that they would avoid recognizing any financial loss on their income statements.  

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.

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