The municipal bond insurance industry would still be thriving today if big banks hadn’t defrauded the insurers.
That’s what executives representing two big bond insurers told a state hearing Wednesday. They claim they were basically tricked by the banks into wrapping toxic residential mortgage-backed securities. They also said the banks now refuse to comply with contracts committing them to repurchase defective loans.
The insurers — banking on big legal settlements to help recapitalize their businesses — have been pursuing the fraud argument through the judicial system since 2008, after the financial crisis devastated the bond insurance business. In recent months, the insurers have been seeking legislative and regulatory assistance to pressure the banks into responding.
The huge losses suffered by the insurers from mortgage-backed securities helped collapse most of the companies, which also are involved in the business of insuring municipal bonds. Insurance penetration has since spiraled downward from more than 50% of the municipal market to less than 10% as most insurers no longer have anything close to triple-A ratings.
Potential winnings from ongoing litigation and out-of-court settlements could be enough to revitalize the industry, executives said before the New York State Assembly Committee on Insurance.
“It’s very clear that problems surrounding the RMBS securities have decimated the financial guaranty insurance business,” said Bruce Stern, executive officer of government and corporate affairs at Assured Guaranty Ltd., the only insurer still writing new policies. “What we’re hoping for here … is to put more pressure on these people to do the right thing.”
Assured has paid $2.8 billion in claims to RMBS investors as of Sept. 30. According to testimony Wednesday, the company has reviewed 36,000 loan files totaling $5.3 billion, and it identified more than 31,000 files as containing breaches of contract that could result in banks repurchasing the loans.
The insurers say most of these products were defective from the start — ineligible for insurance because the loans making up the securitized pool violated the banks’ own underwriting criteria.
MBIA Inc., once the most active insurer and now the most active plaintiff in this litigation, has paid $4.2 billion in mortgage-backed claims through Sept. 30. Chief executive Jay Brown told the hearing he expects the company to pay more than $1 billion in future claims.
When certain pools began defaulting at higher-than-anticipated rates in late 2007, MBIA hired third-party firms to investigate loan files. The results were stunning, Brown said — the firms found that more than 80% of the loans violated underwriting guidelines.
“Documentation violations were prolific,” Brown said, noting that loans were regularly approved when a borrower’s debt-to-income ratio exceeded guidelines. “It was much harder to find loans that were actually eligible for inclusion in the pools than it was to find loans with multiple breaches.”
The insurers say they couldn’t have known this at the time. Reviewing loans on a case-by-case basis before insuring the pool was never feasible, so instead they relied on information from the banks, which would offer representations and warranties within the insurance contracts.
Insurers say the reps and warranties state clearly that if mortgage loans within the insured pools fail to meet stated criteria, the originators of the loans would repurchase or cure the defective loan.
“The contract is clear,” said Dominic Frederico, Assured’s CEO. “The guarantor does agree to pay all claims when presented but can compel the sponsor to repurchase loans that do not meet the agreed-upon standards.”
Through Sept. 30, Assured has obtained $390 million in repurchase commitments, or “putbacks,” as they are commonly called. That number is expected to rise as more settlements are agreed upon, more loan files are reviewed, and as Assured incurs further losses.
Sean McCarthy, chief financial officer at Assured, brought the issue to the Assembly’s attention at an unrelated hearing Dec. 21, when he said “the industry would look completely different today” if the banks would repurchase defective loans.
McCarthy said in December that decisive action to subpoena banks had been taken by regulators on behalf of Fannie Mae and Freddie Mac, and he wanted the New York Insurance Department and state Legislature to take similar action.
Joseph Morelle, D-Rochester, who chaired both hearings, said bank representatives declined to attend. Upon reviewing the testimony, the next step could be to subpoena them.
The New York Bankers Association, a trade group, said reps and warranties were meant to supplement due diligence, not be a substitute for it. It submitted written testimony urging the committee to await the outcome of litigation before adopting new legislation. “It is important to note,” the group added, “that underwriting guidelines are just that — guidelines.”