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 ...www.nycourts.gov/courts/comdiv/.../Rehab%20Frontier.pdf)

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 ...www.kramerlevin.com/.../5377_Alert_DerivCDS_v4.pdf)

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.

2 comments:

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