National Credit’s Citi, Deutsche deals are MBS breakthrough

November 16, 2011

On Monday the National Credit Union Agency announced a pair of breakthrough mortgage-backed securities settlements. Deutsche Bank agreed to pay the government’s credit-union regulator $145 million for its role in underwriting mortgage-backed notes purchased by five credit unions that subsequently failed. Citigroup threw another $20.5 million into NCUA’s settlement pot, which will offset the $5 to $9 billion in fees the agency is charging solvent credit unions to pay for losses associated with the five failed institutions.

As best I can tell, these are the first settlements of MBS securities claims (as opposed to put-back contract claims) since Wells Fargo’s landmark $125 million class action MBS settlement this summer. That means the NCUA deals are just the second and third MBS securities settlements that plaintiffs have scored. They’re also, as the Wall Street Journal noted, the first MBS securities recoveries by a government agency. (Again, I’m distinguishing between securities and put-back claims; Fannie Mae and Freddie Mac both reached put-back settlements with Bank of America in January.)

So, given the paucity of MBS securities settlements, what clues do the NCUA settlements offer for the future of the litigation?

Most crucially, the deals indicate that there’s value in MBS securities litigation — which had been an open question to date. National Credit’s legal team, led by Kellogg, Huber, Hansen, Todd, Evans & Figel, didn’t file complaints against Deutsche or Citi, but NCUA has previously sued Royal Bank of Scotland, JPMorgan Chase, and Goldman Sachs as underwriters on the mortgage-backed notes the five failed credit unions bought. Based on the agency’s most recent complaint, a 175-page behemoth against Goldman that was filed in Los Angeles federal court, NCUA’s theory of recovery is basically what we’ve seen in so many MBS filings: underwriters have broad liability under Sections 11 and 12 of the Securities Act of 1933. Investors aren’t required to show that underwriters intended to defraud anyone, but only that offering materials contained false statements or omissions. The NCUA’s Goldman complaint includes the now-familiar allegations that prospectuses for Goldman-underwritten mortgage-backed notes made false statements about the quality of the loans in the underlying mortgage pools, so Goldman is strictly liable. (The complaint also asserts California and Kansas state-law claims.)

Goldman hasn’t yet filed a motion to dismiss the NCUA case, but RBS’s lawyers at Kirkland & Ellis moved to toss the agency’s parallel case. the RBS motion raises the defenses that just about every MBS securities defendant has trotted out: The failed credit unions were sophisticated investors; the prospectuses were materially sound; and the NCUA’s claims are barred by the statute of limitations and the (more obscure) statute of repose. Presumably, those are the potential arguments lawyers for Citi and Deutsche Bank considered when they analyzed the banks’ odds of getting an NCUA complaint tossed. They nevertheless decided it made sense for the banks to settle.

That’s an encouraging sign, particularly for the Federal Housing Finance Agency and the Federal Depositors Insurance Corporation, both of which have brought Section 11 suits against MBS underwriters. (You surely remember the 17 FHFA cases, which hit the courts like a cluster bomb on the Friday before Labor Day weekend.) Government agencies have more leverage in litigation against regulated defendants — such as banks — than private plaintiffs. That leverage changes the risk/benefit calculation for underwriters considering settlements.

But there’s an interesting reason why NCUA was better positioned for deals than even the other government agencies with MBS claims. The credit union regulator actually knew how much damage its members have suffered from the mortgage-backed securities investments of its five failed institutions. As the NCUA press releases on the Deutsche and Citi settlements explain, the agency repackaged the securities once owned by those five credit unions, obtained U.S. government backing on the new notes, and sold them into the remains of the market for mortgage-backed securities. NCUA raised about $28 billion in the resale.

The resale also permitted the agency to calculate its losses on the MBS underwritten by various potential defendants. That means NCUA can go into settlement talks with a reasonable expectation of damages — and with the facts to back its damages theory. According to an NCUA spokesman, the four underwriter suits that have been filed so far claim $2 billion. It’s a big number, but it’s grounded in actual losses. NCUA’s MBS resale may turn out to have important implications for other cases. Damages have been an open question in the MBS securities litigation. Plaintiffs can demand recission, or buyback of entire bond offerings. That’s not realistic, but it’s why early reporting on the FHFA cases, for instance, generated market-moving headlines about $200 billion in claims by Freddie and Fannie’s overseer. Similarly, the Wells Fargo $125-million settlement was criticized for delivering cents on the dollar for the class’s total noteholdings. The NCUA deals should help other MBS securities claimants, which haven’t repackaged and resold their securities, to estimate damages realistically — a trail marker for damages in litigation that’s proceeding in uncharted territory.

A Deutsche Bank spokesperson said that the bank “is pleased to have resolved the NCUA’s claims without the parties having to resort to litigation.” He declined additional comment and said the bank was not disclosing its outside counsel. Citigroup didn’t respond to my request for comment. A Citi spokesperson said the bank was represented by Paul, Weiss, Rifkind, Wharton & Garrison but declined additional comment.

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