BofA And MBIA Can't Get Enough Of Each Other

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The best and worst part of the long-running feud between MBIA and Bank of America is how it intricately intertwines many strands of lawsuits and stratagems and insurance disputes and market sniping into a single complex tapestry of orneriness. BofA and MBIA are suing each other about everything everywhere, and each case is not really about the thing it's about - it's about getting some leverage in some other case that is in turn itself probably about something else. As far as I can tell, though, the core is mostly:

  • MBIA insured some pre-crisis RMBS securitizations issued by Countrywide (now owned by BofA), and MBIA thinks those were pretty fraudy, which is a pretty widespread view, and so is suing Countrywide/BofA for a $3+ billion dollars in rep and warranty damages;1 and
  • MBIA also wrote Merrill Lynch (now also Bank of America!) some $6 billion in credit insurance/CDS on CMBS, which seems not to have been fraudy, but which MBIA wanted to get out of anyway because the exposures here were weighing down its otherwise potentially viable municipal bond insurance business;2 so
  • MBIA tried to essentially get rid of that CDS exposure by restructuring it into a subsidiary and casting that subsidiary into the fires of Mount Doom.

But that core expands out everywhere, since the only way out of this mess seems to have been deeper in. For instance, Bank of America decided to mitigate the credit risk on that CDS by getting long more MBIA credit, in the form of buying $136mm of MBIA bonds (at par!) and trying to block the restructuring of MBIA. This had the effect of strengthening the credit underlying its CDS contracts and also, one imagines, being annoying and thus scoring some points on the other, technically irrelevant, dispute. There was some suing about that too.3 Also probably some other suing, who can keep track. Lotta suing.

All that ended today, though, with a big-bang, wrap-up-everything-at-once settlement between MBIA and BofA.4 Here's BofA's version:

Bank of America Corporation today announced a comprehensive settlement with MBIA Inc. to resolve all outstanding representations and warranties claims and all other claims between the parties. The agreement requires certain approvals of the New York State Department of Financial Services, which are expected to be received shortly, at which point the parties will execute the agreements and promptly close all contemplated transactions described below.
As part of the settlement, Bank of America will pay MBIA approximately $1.6 billion in cash and remit to MBIA all of the outstanding MBIA 5.70% Senior Notes due 2034 that Bank of America acquired through a tender offer in December 2012. In addition, Bank of America will terminate all of its outstanding credit default swap (CDS) protection agreements purchased from MBIA on commercial mortgage-backed securities (CMBS), as well as terminate certain other trades in order to close out positions between the companies.

Right! Good riddance! Let us never speak of MBIA again, said Bank of America, and vice versa.5Except:

MBIA will issue to Bank of America warrants to purchase 9.94 million shares of MBIA common stock, or approximately 4.9% of its currently outstanding shares, at an exercise price of $9.59 per share. The warrants may be exercised at any time prior to May 2018. Also, Bank of America will provide a senior secured $500 million credit facility to MBIA Insurance Corp.

How odd.6 But you can understand why BofA would want the warrants. It's sort of a beautifully self-fulfilling transaction: MBIA was close to death's door in part because of BofA's actions,7 having lost some 85% of its market cap in the six years since it agreed to insure those Countrywide securitizations. So getting in at $9.59 - a 2.4% discount to Friday's close, though who's counting - is a bargain.

And the settlement gives MBIA a new lease on life, closing out one of its biggest potential cash drains and providing it with enough cash to be more or less solvent at the holding company level while paying back money it'd borrowed from its now-more-viable-looking municipal insurance subsidiary. So the stock closed up 45% on the day, making BofA $47 million on its investment already. They just need 37 more days like today and this settlement will pay for itself.

You can see why MBIA would want the warrants, too. Not just in a "what choice did they really have?" way - presumably they had some leverage since, after all, they got paid $1.6bn and got their bonds back - but also in that it probably makes sense for MBIA to have Bank of America wishing them well rather than ill. Keep your friends close and give your enemies a 4.9% equity stake, is I guess a possible adage, though perhaps not a very wise one.

So it's a clever trade and you have to admire BofA a bit for taking advantage of the situation to make a quick (paper) profit. You could also, if you want, admire the lawyers a bit too, insofar as this settlement intended "to close out positions between the companies" nonetheless includes at least two brand new continuing transactions - the warrants and the line of credit. If things fall apart again, at least there'll be plenty to sue over.

BofA, MBIA Agree to Mortgage Deal [WSJ]
Bank of America Announces Comprehensive Settlement With MBIA Inc. [Bank of America]
MBIA Announces Comprehensive Settlement with Bank of America [MBIA]

1.MBIA's 10-K mentions $3.6bn of putback claims, of which Countrywide is the largest but not the only one. From BofA's 10-K:

The Corporation, Countrywide and other Countrywide entities are named as defendants in two actions filed by MBIA Insurance Corporation (MBIA). The first action, MBIA Insurance Corporation, Inc. v. Countrywide Home Loans, et al., filed on September 30, 2008 is pending in New York Supreme Court, New York County. Damages sought by MBIA include the amount of payments for current and future claims it has paid or will pay under the policies, increasing over time as it pays claims under relevant policies.

I haven't even mentioned the second one!

2.From MBIA's 10-K:

Bank of America and its subsidiary Merrill Lynch also hold a significant amount of our remaining insured CMBS exposures, including the majority of the $6.0 billion of pools originally insured in 2006 and 2007 primarily referencing BBB and lower rated collateral (for a discussion of our insured CMBS pool exposure, see “Results of Operations—Commercial Real Estate Pool and CRE CDOs”). A new recession may result in increased delinquencies, higher levels of liquidations of delinquent loans and/or severities of loss upon liquidation. Although we have also seen stabilization in the delinquency rate over the past several months, loan modifications and extensions granted by the special servicers for these CMBS loans and increased liquidations have contributed to the stabilization. The special servicers are responsible for managing loans that have defaulted and for conducting the remediation and foreclosure process with the objective of maximizing proceeds for all bondholders by avoiding or minimizing loan level losses. While the Company has estimated credit impairments or recorded loss reserves for the CMBS exposures, no material claims have been made to date. It is possible that we will experience severe losses and/or liquidity needs due to increased deterioration on our insured CMBS portfolio or our failure to commute these policies, primarily on exposures with Bank of America/Merrill Lynch, and in particular if macroeconomic stress escalates. Depending on the amount of such claims and the amounts of claims on other policies issued by MBIA Corp., MBIA Corp. may not have sufficient liquid assets to pay such claims in the absence of a settlement with Bank of America/Merrill Lynch and the commutation of the CMBS exposures held by Bank of America/Merrill Lynch or in the absence of the collection of other substantial put-back recoveries. ...

While no claims have been made on these CMBS exposures to date, given the significant erosion of the deductible in some of the underlying insured credit default swaps (“CDS”), we expect that Bank of America and its subsidiary Merrill Lynch will have the ability to make a claim in the near term.

3.At least two kinds! From the MBIA 10-K again:

On December 13, 2012, the Company received a letter from Blue Ridge Investments, L.L.C., a subsidiary of Bank of America, addressed to the Company and The Bank of New York Mellon (the “Trustee”) in its capacity as the trustee under the 2004 Indenture. The letter purports to be a “Notice of Default” under Section 501(3) of the 2004 Indenture (the “Purported Notice of Default”) and alleges that the Second Supplemental Indenture was executed without the requisite consent of holders of the 2004 Notes required by the 2004 Indenture. Pursuant to the 2004 Indenture, if a default continues for a period of 60 days after notice, then the Trustee or the holders of not less than 25% in aggregate principal amount of the outstanding 2004 Notes may declare the principal amount of the 2004 Notes to be due and payable immediately. As of the date of this report, the Company has not received a notice of acceleration of the 2004 Notes. ...

On December 13, 2012, Bank of America also filed a complaint alleging that the Company tortiously interfered with Bank of America’s tender offer to buy all of the 2004 Notes and seeking a permanent injunction against the implementation of the Second Supplemental Indenture and money damages. Bank of America filed an amended complaint on February 19, 2013.

4.BY THE WAY, we talked a little about misplaced diligence earlier today, and in that vein I submit to you that there are two types of job in the world. One is the type where you read paragraphs like this, from the Journal article, and are like "oh of course they did":

The agreement follows on-again/off-again settlement talks over the past six months, said people familiar with the matter. The two sides worked through the weekend, as did Benjamin Lawsky, the New York Department of Financial Services superintendent, to bring about the deal.

If you work at the other type of job you think that's nuts. If you're here, odds are you work at the first type of job.

5.MBIA's version includes:

"We are very pleased to have reached a comprehensive settlement agreement with Bank of America that improves the outlook for MBIA Insurance Corp. and sets the stage for National to reclaim its leadership position in the U.S. public finance insurance market," said Jay Brown, MBIA CEO. "I appreciate Bank of America's efforts to arrive at a fair agreement that resolves a number of legacy issues for both institutions as well as the assistance provided by Superintendent Lawsky and the New York State Department of Financial Services. While work remains to be done, today's announcement represents a significant milestone in MBIA's Transformation for the future and toward our goal of resuming growth in shareholder value."

6.The Journalquotes this guy:

Isaac Gradman, an attorney specializing in mortgage-backed-securities litigation at the firm Perry Johnson Anderson Miller & Moskowitz LLP, in Santa Rosa, Calif., said he had never come across a settlement in this area where one party takes a stake in the other. "It ties the state of these two companies together and gives MBIA an anchor in one of the big-four banks," he said.

7.To the point that MBIA's 10-K pretty much said "our plans for surviving 2013 assume we reach a settlement with BofA":

Our 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 our forecast assumes a settlement with Bank of America including a commutation of insured CMBS exposure, as well as a collection of a substantial portion of MBIA’s RMBS recovery recorded against Bank of America and its subsidiary Countrywide Home Loans, Inc. (“Countrywide”). We believe that a settlement will occur timely because we believe a comprehensive settlement is in the best interests of MBIA Corp. and Bank of America. If, however, MBIA Corp. is not able to reach a comprehensive settlement with Bank of America and Bank of America’s subsidiary, Merrill Lynch, presents substantial claims on its policies covering CMBS pools, MBIA Corp. may have insufficient resources to cover Bank of America’s claims. While no claims have been made on these CMBS exposures to date, given the significant erosion of the deductible in some of the underlying insured credit default swaps (“CDS”), we expect that Bank of America and its subsidiary Merrill Lynch will have the ability to make a claim in the near term. Refer to “RMBS Recoveries and Insured CMBS Portfolio” below for additional information. In addition, Bank of America/Merrill Lynch, is also one of two remaining plaintiffs in the litigation challenging the establishment of National (“Transformation Litigation”), and developments in this litigation may impact the amount MBIA ultimately collects in a comprehensive settlement. While we believe it is more likely than not that a settlement will be reached, which would alleviate its liquidity risk, there can be no assurance such a settlement will be reached timely on mutually acceptable terms. As a result of the risk that MBIA may not reach a settlement with Bank of America within a reasonable period of time, MBIA Corp. could be placed in a rehabilitation or liquidation proceeding by the NYSDFS (an “MBIA Corp. Proceeding”).

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