Who won the $1.7 bln settlement between BofA and MBIA?
On Monday, after word leaked that Bank of America and MBIA had resolved their epic five-year, multidimensional litigation against one another, investors in both companies judged the deal. Shares in MBIA, whose structured finance arm had been widely considered to be on the brink of a regulatory takeover, closed 45 percent higher at $14.29, adding about a billion dollars to the market capitalization of the insurer’s holding company. Bank of America’s shares went up as well. They didn’t rise as dramatically as MBIA’s, closing up 5 percent at $12.88. But that added $6.9 billion to BofA’s market cap – three times as much as the $1.6 billion in cash that the bank agreed to pay to MBIA as part of the settlement.
The comparison between the raw percentage rise in share price and the total dollars added to each company’s market cap is instructive in considering which side, if either, got the better of this settlement. As investor reaction indicated, this deal was much more important to MBIA than to Bank of America. With $1.6 billion in cash from the bank, plus the remittance of $137 million in MBIA notes held by BofA, MBIA’s withered structured finance arm can pay back the $1.7 billion it owes the company’s bond insurance arm, which financed settlements with some of the banks that had challenged MBIA’s 2009 restructuring. BofA also agreed in Monday’s settlement to drop its regulatory and fraud claims stemming from that restructuring, which leaves only Societe Generale remaining in restructuring cases against MBIA. Assuming the insurer can reach a settlement with Societe Generale, the cloud of uncertainty over its 2009 split will be entirely removed and MBIA’s bond insurance arm will be able to return to the business of writing policies on state and municipal financings.
MBIA also eliminated any uncertainty about what it might owe Bank of America under credit default swap agreements with BofA predecessor Merrill Lynch. BofA held a total of $7.4 billion in MBIA policies, $6.1 billion of which was on CDS deals. The actual value of those policies was a matter of speculation and interpretation. I’ve heard that Bank of America had drastically written down its potential recovery from MBIA to the neighborhood of a $1 billion. But if MBIA went into rehabilitation (the insurance version of Chapter 11), the priority of claims by CDS counterparties would have been determined by New York State Department of Finance chief Benjamin Lawsky, who has been deeply involved in settlement talks between MBIA and BofA and might have been using the priority of claims as a bargaining chip. In any event, MBIA’s takeaway from the settlement isn’t just the $1.7 billion in cash and other considerations it received from BofA. It’s really that amount plus BofA’s potential recovery from the CDS policies.
Most importantly, the settlement saves MBIA’s future as an ongoing operating company. Two weeks ago, MBIA was fending off talk that New York regulators were on the verge of putting the structured finance unit into rehabilitation. On Monday, by contrast, state finance chief Lawsky said that the $500 million credit line BofA agreed to provide to MBIA as part of the settlement assured the insurer’s solvency. In cash terms, MBIA did not get all of the $5 billion it claimed Countrywide and Bank of America owed it for misrepresenting the quality of loans underlying mortgage-backed securities insured by MBIA. It didn’t even get all of the approximately $3 billion it has counted as an asset from the long-running Countrywide fraud and breach-of-contract litigation. But it got just enough to get back into the bond insurance business, which means MBIA can eventually revive its once thriving municipal bond insurance business. (BofA, meanwhile, has the option of participating in the upside for MBIA, via five-year warrants on about 10 million shares, or roughly 5 percent of MBIA’s equity.)
For MBIA, in other words, the litigation with Bank of America was truly do or die, which is why its investors reacted so jubilantly to the settlement. For the bank, MBIA has been more like a nasty cold than an existential threat, hence the more muted market response to Monday’s settlement.
But colds can turn into graver illnesses if they linger. Litigation with MBIA has already set all sorts of unfortunate precedent for Bank of America, providing MBIA and other bond insurers with more than one clearly marked path to recovery against MBS issuers. The global settlement comes a little more than a week after New York State Supreme Court Justice Eileen Bransten issued summary judgment rulings that largely adopted MBIA’s view of the law, though Bransten stopped short of ruling dispositively on most of the issues before her.
Only state regulator Lawsky and the top MBIA and BofA executives who spent a year negotiating the global settlement – with the recent addition of a Blackstone financial advisor to MBIA’s board – know for sure if Bransten’s rulings directly impacted talks. It’s certainly interesting to wonder how the settlement calculus might have changed if the judge had granted summary judgment to MBIA on its all-important argument that Bank of America has successor liability for Countrywide’s failings. Would Bank of America have been better off settling early with MBIA and averting troublesome precedent? There’s no doubt, according to monoline lawyer Donald Hawthorne of Axinn Veltrop Harkrider, that MBS plaintiffs’ lawyers are citing rulings from the MBIA case in other litigation against BofA and other MBS issuers. Nevertheless, I bet BofA’s lawyers would say that if they’d had a chance to appeal rulings in the case all the way to the state’s highest court, they’d have prevailed.
And at least Bank of America can stop calculating how the MBIA litigation might impact its proposed $8.5 billion settlement with Countrywide MBS investors, which is ultimately a more important litigation for the bank than the MBIA case, since that proposed settlement would resolve potential put-back claims by thousands of investors, not just one monoline. Indeed, a logical next step for a bank that insists it’s always willing to settle cases on reasonable terms would be a global deal with AIG, which is the leading objector to the put-back settlement and has just won a big ruling in its separate fraud suit against Countrywide. If BofA settled with AIG (and AIG dropped objections to the put-back deal), the bank’s only big remaining MBS case would be the Federal Housing Finance Agency’s securities suit.
I’m already feeling nostalgic about the litigation between MBIA and BofA, which has been one of the most interesting strategic chess matches I’ve ever covered. I was actually beginning to believe that MBIA’s claims against Countrywide would go to trial, and I’ll confess that I would have loved to have seen Justice Bransten preside over that proceeding. Monday’s settlement, however, is the right outcome for both sides. It’s a cliché to say that both sides win when there’s a settlement, but in this case I believe it’s actually true.