Friday, May 31, 2013

Ambac Is Using MBIA's Roadmap in Its Over $1 Billion Representation and Warranty Case Against Bank of America

To those speculators who missed out on an opportunity to profit from MBIA's $2.7 billion settlement with Bank of America (BAC) (you didn't catch that week of May 6th 60% price appreciation in MBIA common stock?), life is presenting you with a do-over, in the form of Ambac's fraud and breach of representation and warranty (R/W) action against BAC.

Moreover, this is a do-over with benefits.  Ambac has the benefit of MBIA's legal roadmap to proceed with its R/W action against BAC in front of Justice Bransten, courtesy of Justice Bransten's own summary judgment opinions in MBIA's now-settled action against BAC.

In MBIA Wins on the Law But Must Go To Trial. Has the Settlement Bid/Ask Spread Just Narrowed? I noted that Justice Bransten's successor liability summary judgment opinion was noteworthy for two reasons.  First, Justice Bransten decided two crucial questions of New York law in MBIA's favor:  (i) New York rather than Delaware law of de facto merger applies to the question of BAC's successor liability, and (ii) there is no requirement to show inadequacy of consideration in de facto merger transactions under New York law.  Ambac is now the beneficiary of these MBIA successor liability opinions by Justice Bransten, given that it is certain that she will apply this same reasoning to the Ambac v BAC case before her.

Second, while Justice Bransten's opinion denied  summary judgment on BAC successor liability, she provided MBIA a roadmap for trial, identifying the (rather thin amount of) fact evidence she felt was still missing at the summary judgment stage of the proceeding, thereby offering MBIA guidance on what additional facts it needed to prove at trial.  With MBIA's case against BAC settled, however, MBIA's trial roadmap was not simply filed away in MBIA's glove compartment. 

Ambac has come out with a second amended complaint in its R/W case against BAC that illustrates the usefulness of Justice Bransten's roadmap when used by another monoline insurer with another in excess of one billion dollar case against BAC (Ambac had paid claims of "over $1 billion" as of June 30, 2011).  In effect, Ambac has reached into MBIA's glove compartment and taken out MBIA's trial roadmap for Ambac's own use in its R/W case against BAC.

At pages 19-45 of Justice Bransten's Summary Judgment Opinon, Justice Bransten reviews the factual allegations made by MBIA to support the de facto merger claim that BAC had succeeded to Countrywide's liabilities because Countrywide's entire mortgage business had been transferred to BAC.  While MBIA's fact allegations of BAC's acquisition of Countrywide's mortgage platform were strong, Justice Bransten concluded that at the summary judgment stage of the case, certain fact questions remained, including in particular whether BAC itself controlled the transfer of Countrywide's mortgage platform to BANA, BAC's North American banking subsidiary, and whether BAC in fact dictated what decisions were made ostensibly by Countrywide.

At the time of the decision, I thought Justice Bransten was being something of a hardass regarding this factual showing, as it was abundantly clear to me that BAC controlled BANA as well as Countrywide, based on the deposition testimony presented by MBIA.  But to Justice Bransten's credit, if she did not think MBIA made the necessary factual showing of BAC's control over BANA and Countrywide sufficient to rule on such control at the summary judgment stage, shame on MBIA and more power to Justice Bransten.  By the way, being called a hardass can be viewed as a term of endearment by a trial judge.

So as Alison Frankel points out in a new post,  Ambac's has amended its complaint recently a second time to assert various claims that BAC has controlled Countrywide since its acquisition, and that Countrywide is simply the alter ego of BAC.

While Ms. Frankel tells you "the what", she doesn't tell you "the why", in connection with this alter ego argument by Ambac.  "The why" is simply that Ambac is focusing on that final yard that, in Justice Bransten's view, MBIA still needed to go in its successor liability argument to prove that BAC exercised control over Countrywide.  This final yard in the trial roadmap is required to show that BAC orchestrated the transfer of Countrywide's mortgage platform to BANA, and that this transfer was tantamount to a transfer to BAC itself.

For the benefit of my lawyer readers, since Justice Bransten interpreted the "cessation of business" prong of the four-part de facto merger analysis as requiring strong evidence that Countrywide didn't operate as a separate entity post-mortgage platform transfer, and she seemed to make a distinction between a transfer of Countrywide's mortgage platform to BANA, as opposed to the ultimate parent BAC, Ambac is essentially folding in an alter ego claim both to stand on its own but, more importantly, to buttress the de facto merger claim.

So, in the case of Ambac's R/W suit against BAC, BAC has certainly seen this movie before...Ambac is "MBIA: The Sequel"...except that Ambac has the financial flexibility that MBIA did not have to rewrite the ending, substituting a judgment after trial in the place of settlement before trial.

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; AMBC.  Follow me on twitter.

Thursday, May 23, 2013

Time for MBIA Management to Take a Bow: Over $3.5 Billion of the $3.8 Billion Insurance Receivable Will Be Recovered in 2013

Just a few months ago, MBIA showed an asset on its balance sheet that MBIA skeptics and bears would sneer at: a $3.8 billion insurance receivable that MBIA expected to recover in its representation and warranty (R&W) actions.

As an MBIA long with a keen interest in these R&W actions, I thought MBIA management had a fighting chance to collect at least the major portion of this receivable over the medium term.  But I could not dispel the criticism that bears brought to MBIA other than to blog here about what I perceived to be the strengths of MBIA's legal position.  Indeed looking back and assessing what my investment posture really was ex ante any insurance receivable recoveries, I have concluded that I was more speculator than investor

With today's filing of the ResCap plan support agreement among ResCap, Ally and ResCap's major creditors, it appears that MBIA will recover between $700 million and $800 million before the end of this year in respect of the ResCap portion of the insurance receivable.  When you add this recovery to the $2.7 billion settlement with BAC (I credit the value of the commutation of BAC's cds policies at $1 billion), and the $110 million settlement with Flagstar,  it appears that MBIA will have recovered about 90% of its insurance recovery receivable at its booked amount.  The remaining recoveries lie with Credit Suisse and J. P. Morgan, wherein an aggregate recovery of $300 million to recover the remainder of the booked insurance receivable no longer seems heroic in light of this recent track record.

Note to MBIA management:  Take Credit Suisse and J. P. Morgan to trial!  You have the financial breathing space (finally), so make them pay!

I believe the investment implications of this remarkable track record of realization on the insurance receivable cannot be overstated.  MBIA's share price still trades at a significant discount to book value (currently less than 50% of adjusted book value).  Yet, what many MBIA bears thought was the frothiest asset recorded on the MBIA balance sheet (and comprising 18% of MBIA's total assets) turns out to have been dead on right.

This is really a remarkable financial achievement by a resourceful MBIA management team.  I believe MBIA is overdue in receiving proper respect by means of a higher share valuation.  If a 50% discount of the share price to book value was premised on the risk of not recovering this $3.8 billion insurance receivable, given this recent track record, isn't it time to start reversing this discount?

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; AMBC.  Follow me on twitter.

Sunday, May 19, 2013

Lessons Learned, and a New Blog Title

It strikes me that the MBIA v BAC saga can serve as a cautionary tale, and afford all of us a rich opportunity to reflect upon what lessons we have learned, as investors, from the litigation and settlement.  Here is my take on some lessons I am still cogitating over:

1. As a shareholder in MBIA, prior to settlement, I was a speculator, not an investor.

I knew this, but I didn't appreciate it as vividly as I do now.  How does one distinguish between an investment and a speculation?  In brief, you know you are a speculator rather than an investor when, in addition to exposing your invested money to the whims of financial fate and often harsh destiny, your return is wholly subject to the subsurface predilections of an overworked and underpaid person wearing a black robe.  I say predilections with full intent, as anyone who thinks that what is involved in a case is only the objective force of the law, and not the subjective biases and too often lazy reasoning failures of that person in the robe, needs to spend some time in court.  It seems to me that the ability of judges if charted would resemble more a barbell than a bell curve, and which end of the barbell you confront as a litigant has an inordinate effect upon your investment.  If that doesn't turn an investment into a speculation, I don't know what does. I will have more to say about this in section 2 below.

In my view, this distinction between investment and speculation should govern the mindset that you bring to the shareholding.

The mindset of an investor should be that losses are not tolerated.  While all investors are human and will suffer losses, the mindset should be to find a stock that offers a margin of safety, and provides reasonable assurance of continued operational and financial success.  No one pointed this out better than Ben Graham, some 80 years ago. One looks for moats, barriers to entry, long term sustainable performance, and most importantly a good entry price.  One looks for what could go wrong, and tries to make sure that there is sufficient likelihood that adverse outcomes will not come to pass.

The mindset of a speculator should be the reverse.  A speculator's mindset should assume, going into the investment, that a complete loss has provisionally been incurred once the stock is bought.  If that assumption is too sour to swallow, the speculator is probably really an investor and should take a pass.  If one can't tolerate a speculative loss, one is really an investor with an identity crisis.  A speculator looks for what could go right, and tries to make sure that there is sufficient likelihood that favorable outcomes will come to pass.

At one point with respect to MBIA, when I was suffering from a particularly virulent bout of MBIA-fatigue (long term holders of MBIA will know what I mean), in order to reinforce this speculator's mindset, I actually wrote onto a sheet of toilet paper the word MBIA and the amount of my holding, and I flushed it into the toilet and watched it swirl away.  This "offering to the gods" actually had a cathartic effect, because it reinforced in my mind the stakes involved, which forced me to reexamine my analysis of the MBIA shareholding. Upon this reexamination, I found that my analysis of a favorable outcome for MBIA was still intact, which reinstilled in me the analytical will to continue to own the stock for what turned out to be a longer period than I had expected.

If my view on the difference between investment and speculation has merit, this implies that an investor should set up two stock accounts, an investment account seeking investments and a speculation account seeking speculations, and maintain an investment Jeckyll and Hyde dichotomy in one's approach to the two accounts.  I have done this, though I have my investment account professionally managed by others, to keep my speculating hands off the investments.  I could do a lot of damage on that side of the ledger.

I suppose my main point is that acknowledging that a stockholding is a speculation doesn't excuse sloppy analysis or shortcuts in diligence. Indeed, such an acknowledgement should only reinforce the care and thoughtfulness that one brings to the speculation.  Speculation should not be disparaged; only speculation masquerading as investment should be shunned.  The best way to avoid mistreating a speculation as an investment is to make sure you bring to the speculation the proper mindset, and therefore bring to the speculation the requisite level of investment diligence.

Moreover, by adopting the speculator's mindset, it is more likely that you will adopt hedging strategies and limit your maximum exposure to an individual speculation than you would if you were simply in investment mode. Since a speculation offers no internal margin of safety, the speculator has to be more careful to bring some measure of safety to the position through the structure of the holding.

But amidst all of these ministrations of caution, let's not forget what likely has attracted you to the speculation in the first place.  You have the opportunity to reap outsized returns, and if you have the proper mindset for the speculation, and therefore approach it with the proper respect for the diligence required, you will come out ahead of the investor, even on a risk-adjusted basis.

Post settlement, I think MBIA has transitioned from speculation into investment.  I think there is substantial support for holding MBIA as an investment, rather than a speculation.  Hence, the change in name of the blog, as this blog will continue even as the MBIA v BAC litigation has ended...and it will focus on remaining speculations in the mbs litigation space.

2.  Even if one is right on the law, one can be wrong on the judge.

Alison Frankel recently wrote an excellent article,  N.Y. judges split on time bar for billion-dollar MBS put-back claims, that serves as the poster child for how a litigant can be right on the law and wrong on the judge.  This is as good as any example of the legal contingency that lies at the core of a speculation in a monoline insurer pursuing mbs recoveries.

The exact same question was presented to New York Commercial Division Justices Kornreich and Sherwood, and they issued two decisions that are diametrically opposed to each other.  One justice is right, and the other justice is wrong.

The question is when does the 6 year statute of limitations start to run on a claim that an mbs originator has breached its obligation to repurchase putback loans. Justice Sherwood stated that the time limitation for claims starts to run from the closing of the original transaction.  In so holding, Justice Sherwood has imposed, like plucking nitrogen out of the air, a judge-created 6 year period during which any and all claims must be asserted that ignores the putback repurchase breach as being separate from the representation and warranty (R&W) breach, in a transaction that can last as long as thirty years and in which the parties to the agreement specified no such limitations.

One wonders whether Justice Sherwood has made any large deposits into his bank account recently.

Justice Kornreich held otherwise and, of course, Justice Kornreich is dead right and Justice Sherwood is dead wrong.  Yet if you are a litigant in front of Justice Sherwood, you have to await the one year appeals process to have the 1st Department reverse this travesty.  This has an effect on your speculative return, and indeed on your willingness to engage in the speculation in the first place.

Another example of being right on the law and wrong on the judge is the question of whether monoline insurers have as a "sole remedy" the putback protocol set forth in the PSA, or whether the monoline can sue for compensatory damages under the NY insurance law.

In this recent example, Justice Bransten was right on the law, and Justice Ramos was wrong on the law.  I will cover this example in a future blog post, but this example has particular significance to speculators in Ambac stock, as two of Ambac's largest R&W cases are in front of, you guessed it, Justices Bransten and Ramos.

In future posts in this blog, I will focus on Ambac's cases in particular, as I have a dog in that fight. Ambac is the monoline that has the largest potential fraud and breach of contract damage recoveries remaining among the monolines, and it appears that it may just be catching the wave.

I use the catching the wave metaphor because you should view the developing caselaw in the mbs litigation space like a rolling wave in front of which various surfers (monolines) are paddling their boards.  MBIA, Assured Guaranty and others have gotten up on their boards earlier than Ambac, and have obtained important settlements (MBIA, Assured Guaranty and Syncora) and a courtroom victory (Assured Guaranty).  But as more decisions are handed down, and the legal position of the monolines becomes increasingly secure, it appears that the mbs litigation wave is rolling to shore with increasing amplitude, and Ambac is now in the best position to catch this wave.

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; AMBC.  Follow me on twitter.

Tuesday, May 14, 2013

Summing Up, and What Next?

When I first invested in MBIA it's stock price (age-wise) was in elementary school.  Now, it is in high school, which is fine since I seem to recall middle school as being a drag. Probably won't wait for college, however.

What can we take away from the MBIA v. BAC saga? Well, I will not pursue the "Who Won?" line of inquiry.  Because in a settlement, both sides win...and lose.  So this monday morning quarterbacking seeks to separate winners from losers in a game of deception, creating more heat than light, but if you want spin, go to another site

Here's a few quick points that I find interesting, and a heads-up for what comes next.


BAC had the cards to win this game flat out, but BAC did horrendous due diligence and it cost BAC at least $1 billion.  BAC's strategy was to squeeze MBIA until MBIA Insurance Corp. was put into rehabilitation, but BAC didn't realize that MBIA had the opportunity to amend its debt indentures to render this rehabilitation much less adverse to MBIA than it could have been.

When you participate in a hostile transaction, the first thing BAC should have done was to do the black binder thing.  Prepare an exhaustive due diligence inventory of every document relating to MBIA, and analyze how BAC could best screw MBIA. 

This is hostile transactions 101.

You may say that this was just litigation, not a hostile transaction, but you would be wrong.  BAC deliberately undertook a litigation strategy to delay and thereby starve MBIA, and so BAC's strategy necessarily included a corporate component, namely how to make sure this financial strangulation process would best play out.  MBIA's corporate structure vulnerability became an essential component of BAC's litigation strategy.

BAC was undeniably stupid in not buying at the outset of the litigation MBIA bonds to establish consent blocking positions in as many MBIA outstanding note issuances as possible.  This would have brought MBIA to the table with no leverage whatsoever.

I have personally seen this stupidity play out at a major investment bank before.  Whenever a relatively minor deal involves the bank itself as principal, the bank always assigns the B team to run the deal, because there is no big bonus for the individual bankers who close that deal, because there is no fee earned by the bank when that deal closes.  That's the incentive structure at big banks; have the back benchers run our own deals since there is no scratch on offer for the A team; makes no sense to run a bank this way.  In this case, BAC's B team earned an F.


On the MBIA side, BAC's strategy was easily discernible and, therefore, could be planned against.  Yet, MBIA could not arrange financing sufficient to keep MBIA Insurance out of rehabilitation so as to run the litigation for another two years to win the $5 billion damage award that was available.  Were there no hedge funds who, based upon an analysis of the litigation, were willing to put up this bridge-to-litigation-award money on acceptable terms?  Apparently not.

What Next?

There is this from BAC's announcement of the MBIA settlement:  "[BAC's] litigation expense includes charges related to the MBIA Settlement as well as adjustments to litigation reserves for other monoline matters, primarily as a result of the experience gained in connection with the MBIA Settlement." 

Who is the most prominent unnamed monoline?


Now, think about Justice Bransten's summary judgment opinions, discussed by me previously at  MBIA Wins on the Law But Must Go To Trial. Has the Settlement Bid/Ask Spread Just Narrowed?   The opinions were a big win for MBIA on the merits, and something of a tactical loss insofar as summary judgment was not awarded.

But those decisions were huge assets for MBIA in its negotiation with BAC because it showed that the most likely outcome of a full trial before Justice Bransten would be that BAC would lose and pay full damages.

Now with the settlement, of course, those decisions are no longer assets for MBIA.  But in the wonderful alchemy of legal analysis, those decisions have become assets of Ambac (due to the persuasive power of the court's analysis), with no corresponding payment made by Ambac.

So the beat goes on, as Ambac continues its mbs fraud and putback litigation against banks, such as JP Morgan (with the NYAG looking over Ambac's shoulder in its own case against JPM), Nomura, Credit Suisse, and....BAC.  Oh, and Ambac's case against BAC is in front of Justice Bransten.

Double NB:  Ambac is just out of bankruptcy and its financial presentation is an utter mess.  Tread carefully or tread not.

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; AMBC.  Follow me on twitter.