Shares of MBIA Inc. jumped by nearly one-third in the last week as traders bet that the bond insurance holding company will win or settle a series of lawsuits.
MBIA is battling to regain the wherewithal to start writing new insurance policies but is mired in more than a dozen lawsuits.
As defendant, the company is trying to justify its February 2009 restructuring in which it took action to protect its municipal policies from its much riskier structured-finance portfolio. As plaintiff, it hopes to win back billions of dollars it paid in insurance on mortgage-backed securities. The insurer is suing mortgage-loan originators for allegedly failing to live up to underwriting standards on loans that were pooled, securitized, and insured by MBIA.
The New York Supreme Court ruled on Dec. 22 that MBIA can use statistical sampling of loans to pursue its case against Countrywide Financial Corp., which was acquired by Bank of America Merrill Lynch. The decision allows MBIA to look at a sample of 6,000 loan files from 15 residential mortgage-backed securities, rather than all the 368,000 files in dispute.
The use of sampling should save both parties significant time and streamline the dispute, said Judge Eileen Bransten, who called the acceptance of sampling “undisputed” in the scientific community.
Brian Moynihan, B of A Merrill’s chief executive, described the mortgage-loan repurchase battle in November as “day-to-day, hand-to-hand combat.”
On Monday, however, the bank agreed to pay $2.8 billion to Fannie Mae and Freddie Mac to settle another case of disputed mortgage loans.
How much exposure Bank of America erased as a result of that agreement hasn’t been disclosed, but the settlement indicates the bank is willing to take steps to move on from the issue rather than contest it in court.
MBIA shares jumped 31% in the last six trading days — up $3.05 to finish Tuesday at $12.84 — the highest since mid-October. The company is battling loan originators in 10 other lawsuits and hopes to receive more than $4 billion from mortgage loan repurchases by those firms, according to National Public Finance Guarantee Corp. chief executive and MBIA president William Fallon.
“We are not talking about technical deficiencies, but about fundamental underwriting criteria,” Sean McCarthy, chief operating officer of bond-guarantor Assured Guaranty Ltd., said about the issue in testimony to the New York State Assembly last month.
MBIA and others believe the originators have a legal obligation to repurchase or cure any bonds backed by the disputed loans. They argue the underlying mortgages did not meet clearly-defined guidelines and cite contracts that stipulate the loan originator would replace any ineligible loan. The company believes that in some cases, more than 90% of the loan files contain breaches of contract. These include unreasonably stated income or lack of income verification, and debt-to-income ratios that exceed guidelines.
MBIA shares also received a boost after several financial institutions announced they were dropping out of the Article 78 proceeding — the main avenue for contesting MBIA’s restructuring.
The restructuring allowed for the creation of municipal bond-insurer NPFG., which now oversees nearly $500 billion of insured debt — the largest in the muni-bond insurance industry. Policyholders of MBIA Insurance Corp., which is now a structured finance bond insurer, contested the legality of MBIA splitting its portfolio this way because it resulted in fewer claims-paying resources for riskier assets.
CIBC opted out of the case against MBIA in late November, while Barclays, JPMorgan and Royal Bank of Canada pulled the plug on their dispute last week. MBIA and the banks haven’t commented on the matter, which is still being pursued by about a dozen institutions. Investors suggested, on the condition of anonymity, that the banks may be linked to structured finance settlements that MBIA announced in second- and third-quarter conference calls. With risky deals settled out of court, the banks would have no reason to sue MBIA, or so the logic goes.
The recent boost in MBIA share value is all the more remarkable given that Standard & Poor’s downgraded it on Dec. 22. The rating agency slashed the muni-insurer to BBB from A with a developing outlook, and cut the structured-finance insurer four notches to B from BB-plus, with a negative outlook.
Gary Galarpe, senior fixed-income trader at San Diego-based Girard Securities, said investors trade MBIA-wrapped bonds based on the underlying rating, so the recent downgrades on the “enhanced” credit had little retail trading impact.
“I wouldn’t say it did nothing, but it’s just one thing on top of another,” he said.
The muni market has been buffeted in recent weeks by concerns about the expiration of the Build America Bond program, a fourth-quarter surge in new supply, concerns about municipal budgets, and predictions by banking analyst Meredith Whitney of widespread defaults, Galarpe said.
MBIA spokesman Kevin Brown said the company is confident it will prevail in its legal battles and re-establish a leadership position in the industry.
“We also continue to make progress in our put-back related litigation, and recently obtained an important ruling from the New York Supreme Court that will allow us to use sampling to establish liability and damages,” he said.
Even if MBIA wins these lawsuits, it has plenty more hurdles to jump in convincing the market that bond insurance is still a valuable product, said Richard Ciccarone, chief research officer of McDonnell Investment Management.
“That’s going to be a public relations challenge, because it’s a matter of perception,” he said. “In the search for greater stock market returns, will they take on risks they shouldn’t take on? And will the market trust them on that?”