Opinion

Alison Frankel

FHFA’s $5.1 bln JPMorgan deal boosts FDIC – but not noteholders

By Alison Frankel
October 28, 2013

The Federal Housing Finance Agency, the Congress-created conservator of Fannie Mae and Freddie Mac, operates independently of the U.S. Justice Department, which is why FHFA was able to announce its $5.1 billion settlement of securities fraud and breach-of-contract claims against JPMorgan Chase on Friday evening, before the much-ballyhooed but as yet unsigned $13 billion global deal between the bank and the government. As you know, FHFA and its lead counsel at Quinn Emanuel Urquhart & Sullivan have been whipping JPMorgan and its fellow bank defendants for as long as the conservator’s cases have been before U.S. District Judge Denise Cote in Manhattan. Facing a June 2014 trial date, and with no higher-court relief from Cote’s rulings in sight, JPMorgan had little choice but to settle FHFA’s claims that the bank and its predecessors Bear Stearns and Washington Mutual duped Fannie and Freddie about the mortgage-backed securities they were peddling. FHFA had all the leverage here.

That’s what makes one provision of the settlement so intriguing. In what I’ve heard was one of the hardest-fought sentences in the agreement, FHFA insisted that JPMorgan waive its right to seek indemnification from the Federal Deposit Insurance Corporation, which sold Washington Mutual Bank to JPMorgan in September 2008, for the $1.153 billion WaMu piece of FHFA’s $5.1 billion deal. The FDIC and JPMorgan have been fighting for years in federal court in Washington about whether the bank or the deposit insurance corporation is liable for claims based on WaMu’s deficient mortgage-backed securities, most notably in litigation in which Deutsche Bank, as the trustee of about 100 WaMu MBS trusts, has asserted a whopping $6 billion to $10 billion in put-backs. JPMorgan’s counsel at Sullivan & Cromwell, meanwhile, have sued in a related case for a sweeping declaration that the FDIC, and not the bank, is liable for all WaMu MBS claims because they weren’t on WaMu’s books when JPMorgan bought the failed bank. U.S. District Judge Rosemary Collyer of Washington has said she’ll decide in the Deutsche Bank trustee case whether JPMorgan or the FDIC is stuck with responsibility for deficient WaMu mortgage-backed securities. Discovery is under way in her court on the terms of the 2008 agreement under which JPMorgan acquired WaMu.

In Friday’s deal, FHFA could easily have ignored any potential exposure for the FDIC. Its settlement, after all, is with JPMorgan, and if the bank subsequently sued the FDIC to get back the WaMu piece of the deal, FHFA wouldn’t be affected. But instead, FHFA insisted that the bank expressly give up indemnification claims from the deposit insurance corporation for what it is paying out to Fannie and Freddie for WaMu’s toxic MBS. For the sake of appearances, if nothing else, that’s an important concession from JPMorgan.

There is, however, a very big loophole in the FHFA settlement that will permit the bank to attempt to recoup its entire WaMu payout. The FDIC provision of the FHFA agreement bars JPMorgan from seeking indemnification from the corporation – but not from the FDIC’s separate $2.7 billion WaMu receivership, which consists (roughly) of the $1.9 billion JPMorgan paid for WaMu in 2008 plus another $800 million that the fund recovered through the Chapter 11 bankruptcy of WaMu’s holding company. In the FHFA deal, the conservator agreed to a steeper discount on Fannie and Freddie’s WaMu claims than those against JPMorgan and Bear Stearns. I suspect that’s no coincidence: The allocation of FHFA’s total recovery permits JPMorgan to attempt to get all of its $1.153 billion WaMu payout from the FDIC’s WaMu receivership.

In other words, the FHFA walled off FDIC’s corporate exposure to JPMorgan indemnification claim, but it left the $2.7 billion receivership exposed to the tune of $1.153 billion.

JPMorgan will have to fight off some extremely determined WaMu secured noteholders to get at that receivership cash, though. A group of hedge funds that includes Monarch, Silver Point and York Capital, owns more than $6 billion in WaMu senior notes. The noteholders are of the view that all of the money in the WaMu receivership belongs to them, as the secured creditors of a failed bank. But if JPMorgan were to win an indemnification judgment against the receivership, it would move to the front of the line for payment. A dollar to JPMorgan from the WaMu receivership is a dollar directly out of the WaMu bondholders’ pocket – and there are only $2.7 billion of those dollars to begin with.

The senior bondholders, moreover, have no say in the litigation that – at least as things now stand – will decide whether WaMu MBS liability belongs to JPMorgan or the FDIC. The hedge funds’ lawyers at Dechert and Zuckerman Spaeder moved to intervene in the Deutsche Bank trustee case in Washington, but Judge Collyer ruled they don’t have standing, a decision that was affirmed in July by the D.C. Circuit Court of Appeals. It will be up to the trustee’s counsel at Boies, Schiller & Flexner and Talcott Franklin and the FDIC’s lawyers at Hughes Hubbard & Reed to argue that JPMorgan assumed responsibility for WaMu MBS liability when it bought the bank.

The FDIC’s entanglement with claims by private investors in WaMu mortgage-backed securities creates considerable complications for the government. You can see why the Justice Department would like to resolve the question of the FDIC’s indemnification as part of a global settlement with JPMorgan. The FHFA agreement offers a possible path to an agreement by restricting the bank to claims against the $2.7 billion WaMu receivership.

Such a deal would be bad news, though, for the FDIC’s allies in private indemnification litigation against JPMorgan. Deutsche Bank and the MBS investors in the WaMu trusts it oversees need the FDIC to continue arguing alongside them that JPMorgan is liable for WaMu’s supposed MBS contract breaches. The hedge funds that hold WaMu notes need the FDIC to remember its fiduciary duty to represent their interests as WaMu creditors in any global settlement talks with JPMorgan. And some of the failed banks for which the FDIC acts as a receiver need the agency to pursue their claims as holders of JPMorgan, WaMu or Bear Stearns mortgage-backed securities. No wonder the FDIC piece of the global settlement is reportedly complicating negotiations.

If the government settlement with JPMorgan does not fully resolve the issue of FDIC indemnification, the docket in the trustee case before Judge Collyer calls for final briefing to conclude in the spring of 2014. JPMorgan’s lawyers at Sullivan & Cromwell contend in a related case that if WaMu MBS investors haven’t already asserted put-back claims against the FDIC as receiver, they’re too late under the four-year statute of limitations set forth in the Financial Institutions Reform, Recovery and Enforcement Act. That interpretation of FIRREA would bar put-back suits by about 100 WaMu MBS trusts outside of Deutsche Bank’s trusteeship. But even if JPMorgan is right about the time bar and is correct that Deutsche Bank has inflated put-backs in the WaMu trusts it oversees, JPMorgan still has billions of dollars at stake in the FDIC indemnification dispute.

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