|Shares Out. (in M):||193||P/E||0.0x||0.0x|
|Market Cap (in $M):||1,750||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||798||EBIT||0||0|
|TEV (in $M):||2,548||TEV/EBIT||0.0x||0.0x|
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A stock that trades on scary headlines presents opportunity. I believe MBI is currently one such opportunity. The recent headlines that MBI hired Weil Gotshal as an advisor for its MBIA Insurance Corp subsidiary (“MBIA Corp”) and that NY insurance regulators (“NYSDFS”) are close to putting MBIA Corp into rehabilitation have pressured MBI shares. However, the near-term prospect of a MBIA Corp rehabilitation may finally push the parties (MBI and BAC) toward a negotiated settlement of the long-running MBIA v. Countrywide case. A settlement would create more value for all parties involved, but in the event that MBIA Corp is put into rehabilitation, there is unlikely to be much, if any, downside at current prices.
The MBI thesis is fairly simple, but the details are complicated. I’ll start with the corporate structure of MBI and the consent solicitation that ring-fenced MBIA Corp from the rest of MBI.
2009 Transformation & 2012 Consent Solicitation
MBI undertook a transformation in 2009 by splitting its business into two subsidiaries: National Public Finance (“National”) and MBIA Corp. National is MBI’s plain vanilla U.S. municipal insurance business. MBIA Corp is the parade of horribles global structured finance business.
During Q4 2012, MBI successfully completed a consent solicitation with holders of its senior notes removing any cross-defaults with MBIA Corp. MBIA Corp can now be put in rehabilitation without any adverse consequences to MBI or National.
BAC has a vested interest in stopping the transformation and consent solicitation because BAC is the counterparty to some of the worst risk at MBI Corp. From MBI’s 10-K: “Currently, we insure eight static CMBS pools, having $6.0 billion of gross par outstanding… most of MBIA Corp.’s estimated credit impairments for our static CMBS pools relate to a subset of these eight pools, of which the vast majority relate to a single counterparty, Bank of America.”
BAC sued to challenge the transformation by alleging the NYSDFS acted in an “arbitrary and capricious” manner in allowing the split. The trial court ruled against BAC in March (http://www.mbia.com/investor/publications/Article-78-Decision-03-04-13.pdf).
In attempt to stop the consent solicitation, BAC tendered for the relevant MBIA notes and then unsuccessfully tried to declare MBI in default. BAC stated in the press release, “BAC believes that if the MBIA Consent Solicitation is successful, the risk of MBIA Insurance Corporation being placed in rehabilitation or liquidation will increase, which would jeopardize all policyholder claims, including Bank of America’s claims under these transactions.” (http://newsroom.bankofamerica.com/press-release/corporate-and-financial-news/bank-america-announces-commencement-cash-tender-offer-mbi)
BAC obviously wants the resources of MBI and National available to pay claims at MBIA Corp. However, BAC was unsuccessful and is now exposed to losses in a MBIA Corp rehabilitation.
Effect on MBI of a MBIA Rehabilitation
Before I get to why a negotiated settlement would be in BAC’s interest, I want to discuss the potential adverse effects of a MBIA Corp rehabilitation to MBI.
There is $3.9b of book value at the National subsidiary, which equates to $20/share at the MBI level. National made a $1.7b secured loan to MBIA Corp, which was approved by the NYSDFS. The loan is at the top of the capital structure, senior to both policyholders and other debt, and secured by MBIA Corp’s future put-back litigation recoveries (i.e., any recovery/settlement from MBIA v. Countrywide and other cases), among other assets.
The obvious risk to MBI concerns the fate to the National loan in a MBIA Corp rehabilitation. Would the NYSDFS, which approved the loan terms, compromise the loan to favor MBIA Corp policyholders at the expense of National’s municipal bond policyholders? Especially when the NYSDFS approved the 2009 split of National and MBIA Corp to provide counter-party certainty in the muni bond market? The NYSDFS has wide discretion, but I believe the regulator would not compromise the National loan. There are $17.2b of assets at MBIA Corp.
Even if we were to zero out the loan, National would still have $2.2b of book value, or $11.59/share at the MBI level. Moreover, with MBIA Corp and all its associated issues removed from the corporate structure, MBI could finally move forward with National. Once National gets the requisite ratings from the rating agencies, it could begin to write muni bond insurance again and generate earnings.
Benefits of a Negotiated Settlement
BAC expended significant effort to avoid a MBIA Corp rehabilitation, and while a rehabilitation would not have serious adverse effects on MBI, I presume the company would like to retain the residual value of MBIA Corp ownership. A negotiated settlement of MBIA v. Countrywide is in the mutual interest of MBI and BAC. As stated in MBI’s 10-K: “Management’s expected liquidity and capital forecast for MBIA Corp. for 2013 reflects adequate resources to pay expected claims. However, there is a significant risk to this forecast as MBIA Corp.’s forecast assumes a settlement with Bank of America including a commutation of insured CMBS exposure, as well as collection of a substantial portion of MBIA Corp.’s put-back recoverable recorded against Bank of America/Countrywide. Management believes that a timely settlement will occur because it believes a comprehensive settlement is in the best interests of MBIA Corp. and Bank of America.”
A settlement of MBIA v. Countrywide would hold many benefits for BAC. First, BAC would fund its counter-party and allow MBIA Corp to pay BAC’s claims as they arise. Second, even in rehabilitation, the NYSDFS would continue the MBIA v. Countrywide suit and I believe it is in BAC’s interest to make lawsuit go away. Substantive legal rulings on many issues in MBIA v. Countrywide could endanger the $8.5b settlement BAC reached with investors in 530 Countrywide mortgage trusts. Losses on these trusts are estimated to be over $100b, so BAC settled these losses for pennies on the dollar.
Gibbs & Bruns Settlement and Article 77 Hearing
BAC’s $8.5b settlement is colloquially called the Gibbs & Bruns settlement for the law firm that represented BNY as trustee (http://www.gibbsbruns.com/files/Uploads/Documents/Settlement%20Agreement.PDF).
The settlement was originally announced in 2011, but by its own terms, has no legal effect until it is approved by a NY court in an Article 77 proceeding. The key issue in the Article 77 proceeding is whether BNY, as trustee, acted in a reasonable manner. There have been many investors, including AIG and three FHLBs, that have since objected to the reasonableness of the settlement. If the settlement is not approved, BAC’s liability for these Countrywide trusts could be multiples of the $8.5b settlement figure. It is clearly in BAC’s interest that the Gibbs & Bruns settlement be approved by the court.
At the heart of MBIA v. Countrywide, the Gibbs & Bruns settlement, and other similar litigation is whether an issuer of RMBS is liable to repurchase securities due to breaches of representations and warranties.
Since the execution of the Gibbs & Bruns settlement, a number of legal rulings have undermined the bases put forth by BNY and BAC to support the reasonableness of the settlement. BNY put forth two main arguments to support the reasonableness of the settlement:
1) Successor Liability: The value of the settlement far exceeds the judgment paying ability of Countrywide and BAC does not have successor liability for Countrywide. Quoting from the BNY’s memorandum in support of the settlement: “Countrywide’s position that the Trustee could not impose liability on Bank of America under theories of successor liability, veil piercing, or de facto merger is reasonable. That judgment is supported by well established precedent and recent cases seeking to impose liability on Bank of America for Countrywide’s alleged misconduct, and has been reinforced by an independent expert legal opinion.”
2) Loss Causation: “Countrywide will assert as a defense that in order to satisfy the PSA’s requirement that any breach of representation ‘materially and adversely affect the interests of the certificateholders in the Mortgage Loan,’ the Trustee would have to prove, on a loan-by-loan basis, that the breach caused a substantial loss to Certificateholders. This defense is a reasonable one, and if accepted by a Court, could mean that the Trustee would have to bear the extraordinary burden of reviewing loan files for hundreds of thousands of loans (or a significant sample of such loans) in 530 trusts; determine as to each loan which of the dozens of representations and warranties were breached; and then prove that the loss to Certificateholders was caused by the breach of a specific representation and warranty and not by other factors that arguably bear no relation to the breach. The Trustee’s good faith judgment that the defense is reasonable is supported by case law addressing nearly identical PSA language under similar facts, and by an independent expert legal opinion.”
The loss causation argument has subsequently been dealt a death blow. In February, Judge Rakoff ruled in Assured Guaranty v. Flagstar that “the causation that must here be shown is that the alleged breaches cause plaintiff to incur an increased risk of loss…it is irrelevant to the Court’s determination of material breach what Flagstar believes ultimately caused the loans to default, whether it is a life event or if the underwriting defects could be deemed ‘immaterial’ based on twelve months of payment. Risk of loss can be realized or not; it is the fact that Assured faced a greater risk than was warranted that is at issue for the question of breach.”
Moreover, on April 2, a NY appeals court, hearing an appeal from the MBIA v. Countrywide case, ruled that MBIA “is entitled to a finding that the loan need not be in default to trigger defendant’s obligation to repurchase it. There is simply nothing in the contractual language which limits the defendants’ repurchase obligations in such a manner…Thus, to the extent plaintiff can prove that a loan which continues to perform ‘materially and adversely affect[ed]’ its interest, it is entitled to have defendants repurchase that loan.” Taken together with the Assured Guaranty ruling, a breach of reps and warranties, so long as it increased the risk of loss, is all a plaintiff must show to activate the repurchase obligation.
Thus far, there have been no legal rulings on the issue of BAC’s successor liability for Countrywide. However, this is one of the key issues in MBIA v. Countrywide and absent a settlement, the judge will eventually make a ruling. If BAC loses on successor liability, and I believe it will, then the two main arguments used to support the reasonableness of the Gibbs & Bruns settlement would have been defeated.
The preservation of the Gibbs & Bruns settlement is another key incentive for BAC to make MBIA v. Countrywide go away.
MBIA vs. Countrywide: Successor Liability
Judge Bransten recently denied both BAC’s and MBIA’s motions for summary judgment on the issue of successor liability. This resulted in scary headlines like “MBIA Loses Bid for summary judgment Against BAC’s Countrywide”, which moved the stock down. Of course, the headline could have also accurately read, “BAC’s Countrywide Loses Bid for Summary Judgment Against MBIA”.
Both BAC and MBI made summary judgment motions and the judge denied them both because, as anyone who had has the (dis)pleasure of sitting through first-year civil procedure knows, summary judgment is an extraordinary remedy. A court will only issue summary judgment when a party has provided evidence sufficient to eliminate any material issues of fact and thus is entitled to judgment as a matter of law. The judge found there were still disputed material facts that require trial to resolve.
MBI did score an important victory in the summary judgment opinion. The judge ruled that NY law applies to the question of de facto merger and successor liability. BAC had argued that Delaware’s de facto merger law applies. NY law is much more favorable to MBI.
I also believe a fair reading of the opinion gives an indication that Bransten is favorably disposed to MBI’s arguments. Under NY de facto merger law, a judge is to consider four factors: (1) continuity of ownership; (2) cessation of ordinary business and dissolution of the acquired corporation as soon as possible; (3) continuity of management, personnel, physical location, assets and general business operation; and (4) assumption by the successor of liabilities ordinarily necessary for the uninterrupted continuation of the business of the acquired corporation.
With regard to the first factor, Bransten wrote, “Moreover, even if this Court were to find that MBIA is entitled to a finding of ownership continuity, this finding would not be sufficient in and of itself to grant MBIA’s motion.” This seems to imply that MBI had made a showing sufficient for summary judgment on this factor. As for the other three factors, none of the disputed facts brought up by Bransten in the opinion appear beyond MBI’s ability to prove. I think it is important to note that MBI faces a much lower burden of proof at trial. To win summary judgment, MBI had to show evidence sufficient to preclude material disputes. At trial, MBI need only establish facts with a preponderance of the evidence to prevail.
MBI has piled up a series of small victories in MBIA v. Countrywide and the probability that MBI prevails on the merits continues to increase. Given the ruling in Assured Guaranty, MBI can show Countrywide is primarily liable because breaches of reps & warranties increased the risk of loss. For example, if the governing RMBS contract represented that a “qualified appraiser” was used, when no such appraiser was used, then that is shoddy underwriting; and the purpose of underwriting is to reduce the risk of loss. Res ipsa loquitur as the lawyers like to say. MBI also stands a good chance of showing BAC is liable as a successor to Countrywide through NY’s de facto merger law. Indeed, in its most recently quarterly conference call, BAC answered a question about developments in MBIA v. Countrywide by stating, “And you should assume that there was some additional moneys during the quarter in litigation expense that was set aside for the monolines.”
Timing & Conclusion
Litigation always takes longer than anyone thinks, but I believe with the imminent and well-telegraphed rehabilitation of MBIA Corp will be a strong catalyst to force BAC and MBI to agree on a settlement number. MBI’s CEO stated in the last conference call:
“We will continue to be motivated to reach a negotiated settlement because of the potential disruption and loss of value that would be triggered by a regulatory proceeding against [MBIA Corp]. In addition I believe that Bank of America will also be motivated to achieve a settlement in order to avoid having their CMBS claims substantially diluted and delayed. Settlements occur when the perceived economic values converge and there's substantial drivers we think should suggest such a convergence. However if that is wrong, both companies will be damaged as a consequence. Moreover as I've said in the past, we will not accept a non-economic settlement.”
It is important to note that MBI’s CEO owns 4.4mm shares of stock worth $40mm at current prices. His most recent open market purchases were at $10, $9.01, and $7.50 per share in 2010 and 2011.
I also think it’s important to note how publicly recent events have played out. The WSJ carried that story that MBI had retained Weil Gotshal according to “people familiar with the matter”. Someone wanted this to leak. The NY Post story stated that “New York state regulators are poised – within “weeks or perhaps days” – to seize the company’s money-losing mortgage insurance arm because it is running out of cash, a source close to the situation said.” There are parties that clearly want to make sure BAC knows what is in the near-term pipeline.
BAC is faced with the following facts. If BAC chooses to let MBIA Corp go into rehabilitation, BAC is exposed to many billions of CDS losses (which it struggled mightily to prevent), the NYSDFS would continue the MBIA v. Countrywide put-back litigation, and BAC would still be exposed to an adverse legal ruling that jeopardizes the Gibbs & Bruns settlement. A negotiated settlement would make all these issues go away.
For MBI, a settlement would avoid a rehabilitation of MBIA Corp and preserve the residual value of the subsidiary. I think the NYSDFS would also like to see a settlement. Rehabilitation would put the NYSDFS in the awkward position of deciding what to do with the National loan.
The risk is that neither MBI nor BAC will act rationally. Protracted litigation tends to do that to people. I would hope that the large insider ownership at MBI and the importance to BAC of preserving the Gibbs & Bruns settlement would prove sobering to both parties.
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