Opinion

Alison Frankel

MBS investors and the ResCap deal: making the best of a bad situation

By Alison Frankel
May 23, 2013

A little more than a year ago, when the mortgage lender and onetime Ally Financial subsidiary Residential Capital entered Chapter 11, investors in 392 ResCap mortgage-backed securities trusts announced that they’d reached a pre-bankruptcy deal permitting them an allowed claim of $8.7 billion for ResCap’s breaches of representations and warranties. The deal didn’t promise that investors would end up with $8.7 billion, since they’d be in line behind secured creditors and would have to share with other unsecured creditors in whatever meat remained on ResCap’s carcass. But as I reported at the time, the allowed claim deal did appear to make MBS investors represented by Gibbs & Bruns, Ropes & Gray and Talcott Franklin the biggest unsecured creditors in the bankruptcy.

So why, in the ResCap global plan disclosed Thursday, are the MBS trusts projected to recover just $672.3 million of the $2.53 billion that’s expected to be paid out of the estate? Their 28.4 percent recovery is less than the 33.6 percent of the estate (or $796.3 million) that’s projected to go just to the bond insurer MBIA and far less than the total 43 percent ($1.099 billion) of ResCap’s remains that are slated to be paid to monoline insurers.

There’s been tremendous controversy in the bankruptcy about the original $8.7 billion MBS allowed claim deal. Other ResCap unsecured creditors, including junior and senior unsecured noteholders, have asserted that the MBS investors made a backroom deal with Ally, garnering its support for their allowed claim in return for a pledge of support for Ally’s $750 million settlement with its former subsidiary. Creditors subsequently torpedoed that $750 million Ally deal, forcing the multiparty negotiations that produced the global resolution revealed Thursday, which includes a $2.1 billion payout from Ally, almost triple its original settlement. In the new plan, the allowed put-back claim for MBS investors is $7.3 billion, which means that their projected recovery of $672.3 million gives them about nine cents on the dollar.

Those numbers don’t look great, but there are a couple of critical points to keep in mind. First of all, the original $8.7 billion allowed claim deal included trusts that were backed by bond insurers and trusts that were not guaranteed (in MBS parlance, unwrapped trusts). But put-back claims in wrapped trusts really belong to the insurers, not to investors who’ve already been compensated by insurers for their losses. And indeed, monolines had brought their own billion-dollar claims against ResCap. So the global deal outlined Thursday distinguishes compensation to wrapped and unwrapped trusts. Monolines get secured claims based on what they’ve paid out to investors in wrapped trusts; investors in unwrapped trusts get allocations from the $672.3 million projected recovery on their revised $7.3 billion allowed claim. (Unfortunately, I couldn’t get hold of the total number of unwrapped trusts covered by the deal.)

It’s also important to remember that MBS investors would have recovered more cents on the dollar if the ResCap estate had been bigger. In the newly disclosed global deal, Ally will kick in $1.35 billion more than it originally pledged. The sale of ResCap’s servicing rights also brought in about $1 billion more than had been originally projected. But the estate also had to pay hundreds of millions to federal regulators in connection with the sale of the servicing business. The bankruptcy proceedings, meanwhile, were eating away at ResCap’s remains. As my Reuters colleague Tom Hals has reported, just the examiner’s report – which was supposed to be finished in 90 days and ended up taking 11 months – is expected to cost $82 million. If there had been no global deal, ResCap, the creditors’ committee and the MBS investors were looking at a five-day trial next week to figure out the size and priority of investors’ put-back claims. It’s not outside the realm of possibility that by the time U.S. Bankruptcy Judge Martin Glenn resolved all of the tough questions that arise in every MBS litigation – not to mention the novel Chapter 11 issues – there would have been nothing left of ResCap.

MBS investor counsel Kathy Patrick of Gibbs & Bruns told me Thursday that the deal is better than she expected six months ago. “It’s a significant achievement in an extremely complex case,” she said. (The term sheet specifies that counsel for MBS investors are entitled to 5.7 percent of their clients’ recovery, or about $38 million.)

I should also note that the global deal settles securities claims as well as put-back claims, including securities claims against Ally. A long-running MBS class action in federal court in Manhattan will be settled for $100 million. Suits by another 21 individual MBS investors – including AIG, Allstate, MassMutual, and several Federal Home Loan Banks and foreign banks – will be resolved for a total of $225.7 million. The deal does not resolve the Federal Housing Finance Agency’s suit against Ally.

(This post has been corrected. An earlier version incorrectly referred to Ally Financial as Ally Bank.)

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