Opinion

Alison Frankel

Why Countrywide bankruptcy likely won’t solve BofA MBS problems

Alison Frankel
Oct 11, 2011 19:24 UTC

The drumbeat of calls for Bank of America to put what remains of Countrywide into Chapter 11 has grown so loud and relentless that according to a report last month by Bloomberg, BofA is actually considering what’s been called the “nuclear option.” Resorting to a Countrywide Chapter 11 would be fraught with unknown but surely devastating consequences for a commercial bank, as bankruptcy guru Harvey Miller of Weil, Gotshal & Manges explained in a fascinating Bloomberg video. But more significantly, there’s a good chance it wouldn’t accomplish the intended goal of roping off BofA’s liability for Countrywide’s mortgage-backed securities mess.

If Bank of America can succeed in limiting its MBS litigation losses to Countrywide’s remaining assets, it will have to show that it didn’t assume liability for Countrywide’s conduct when it acquired the mortgage company in 2008. That’s known as successor liability, and it was one of the key questions Bank of New York Mellon considered as it weighed the fairness of BofA’s proposed $8.5 billion settlement with Countrywide MBS investors. BNY Mellon’s expert, Professor Robert Daines of Stanford Law School, produced a 58-page treatise that concluded it would be very difficult for MBS investors to establish BofA’s successor liability.

Professor Daines looked at a variety of theories plaintiffs could pursue to stick BofA with the hot potato of Countrywide MBS liability. Most, he said, are non-starters, but if there’s any route to successor liability it would probably be through an argument, under New York law, that BofA’s acquisition of Countrywide was a de facto merger. There’s a four-prong test for such a determination, according to the professor, but its interpretation depends to a very large extent on the judge hearing the case. “The doctrine is thus unpredictable and there is even a disagreement about how the four-factor test should be applied: several decisions suggest that the courts apply a ‘flexible’ standard: i.e., they consider all of the factors and that any of these factors could trigger a de facto merger,” Professor Daines wrote in the analysis for BNY Mellon.

In other words, if a New York judge decides an acquiring company should be tagged with the liabilities of its target, the judge has a lot of discretion to make it happen. BofA didn’t have to look very far for proof of that. In April 2010, New York supreme court judge Eileen Bransten refused to dismiss allegations that BofA has successor liability for MBIA’s MBS claims against Countrywide. She found that MBIA offered sufficient evidence — the judge noted in particular that BofA had stripped Countrywide of its assets and shut down the Countrywide brand — to assert the deal was a de facto merger. Judge Bransten ruled that BofA must remain a defendant in MBIA’s case under MBIA’s successor liability theory.

It’s significant that when Countrywide and BofA appealed parts of Judge Bransten’s April 2010 ruling to the state’s appellate division, the defendants didn’t ask for review of her finding on successor liability. Typically, when defendants don’t appeal a ruling like that, it’s because they’re worried about setting appellate precedent that will guide future determinations on the same issue. BofA didn’t show a whole lot of confidence in its arguments against MBIA’s de facto merger theory when it let stand Judge Bransten’s preliminary ruling on its successor liability.

BofA didn’t have to fork over $11 million to departed execs

Alison Frankel
Oct 11, 2011 00:01 UTC

This post was co-written with Erin Geiger Smith.

Like hundreds other Twitterati this weekend, we read with righteous amusement Joshua Brown’s Reformed Broker screed against Bank of America. The bank, you probably know, disclosed Friday in a Securities and Exchange Commission filing that it is paying former executives Sallie Krawcheck and Joseph Price a total of $11 million for the pleasure of their departure, a year-long non-compete agreement, and a promise not to sue for, as the British say, being made redundant. The Reformed Broker found the deal offensive, to say the least.

“This is why they hate you and want you to die,” Brown wrote, in a post that ricocheted around Twitter like tween commentary on Kim Kardashian’s wedding. “Elevenmilliondollars? What the hell world are you inhabiting?” Brown wrote. “You look completely ridiculous with news like this at a time when thousands of people are massing in every major city in the country to make the case that you don’t deserve to exist. At a time when you’re being investigated for employing robosigners just to maintain a certain level of foreclosures processed per month. At a time when you’re laying off rank-and-file employees not by the hundreds, not by the thousands — but in the tens of thousands…This Is what you do with the money? With OUR money? Are you crazy?”

We assumed — and we know we’re not alone in this — that BofA had to fork over the $11 million to Krawcheck and Price because the October 6 “separation agreements” were part and parcel of their prior employment contracts. That was the infuriating but understandable explanation AIG offered in 2009 when Congress raked it over the coals for paying $169 million in bonuses to some of the execs who cratered the company.

Bond insurers v. banks: MBS loss causation teed up for ruling

Alison Frankel
Oct 10, 2011 21:57 UTC

Last week a rumor made the rounds of hedge funds that trade in Bank of America and MBIA shares: The bank had reputedly agreed to settle the bond insurer’s mortgage-backed securities fraud and put-back claims for $5 billion. The rumor turned out to be false, or at least premature, since no settlement is in the offing at the moment. But the size of the rumored deal gives you a sense of the magnitude of the litigation between the banks that packaged and sold mortgage-backed securities and the bond insurers that wrote policies protecting MBS investors. We are talking about billions of dollars — perhaps tens of billions — at stake in suits by MBIA, Syncora, Ambac, and Financial Guaranty against Countrywide, Credit Suisse, GMAC, Morgan Stanley, and other MBS defendants.

Last week, Manhattan state supreme court judge Eileen Bransten, who has been the leading jurist in the bond insurer cases against MBS issuers, heard oral arguments on the issue that will determine the magnitude of the banks’ liability: Can bond insurers demand damages based on banks’ misrepresentations on the day deals were signed? Or can MBS issuers point to the housing bust, and not their deficient underwriting, as the reason so many loans have gone bad in the years after the MBS were sold? The case argued Wednesday before Judge Bransten concerned summary judgment motions in the MBIA and Syncora suits against Countrywide, but as the judge noted in her introductory remarks to the overflow crowd in her courtroom, “I understand that this [argument] has a major impact on lots of people.”

For everyone who couldn’t squeeze into Judge Bransten’s courtroom, I’ve gotten hold of transcripts of the day-long hearing. I’m going to focus on the morning session on the loss causation issue, but here’s a link to the afternoon session on consolidating the issue of Bank of America’s successor liability for Countrywide MBS, which is specific to BofA.

Did Gibbs pre-empt rival investor group in BofA’s MBS deal?

Alison Frankel
Oct 3, 2011 22:23 UTC

The most dramatic moment at the Sept. 21 hearing on Bank of America’s proposed $8.5 billion settlement with Countrywide mortgage-backed securities investors came near the end, when Gibbs & Bruns partner Robert Madden stood up to address Manhattan federal judge William Pauley’s concerns about how the settlement came to be. Tall and clear-spoken, Madden captured the judge’s attention as he explained that his clients, a group of 22 large institutional investors, hadn’t entered a sweetheart deal with BofA, but had banded together to force the bank to pony up billions to investors for claims BofA thought it would never have to deal with.

“The problem was that these repurchase claims were lying fallow,” Madden said, according to the transcript of the hearing. “No one was doing anything. None of (the investors now objecting to the deal) were doing anything. And, I’m sorry to say, the trustee wasn’t doing anything. Limitations were running on those claims, and nothing was happening.”

Or was it?

I’ve learned that in the summer of 2010, as Gibbs & Bruns began to push Countrywide MBS trustee Bank of New York Mellon to act on its assertions that mortgages underlying the Countrywide securities were deficient, another group of Countrywide MBS investors was finalizing its own notice of default to serve on BNY Mellon. Members of the RMBS Clearinghouse, run by former Patton Boggs partner Talcott Franklin, had undertaken an extensive analysis of the underlying Countrywide mortgages, and, according to two sources familiar with the Clearinghouse’s activities, were on the verge of sending BNY Mellon a notice that would trigger put-back litigation.

Bank of New York: We have no fiduciary duty to MBS investors

Alison Frankel
Sep 30, 2011 22:26 UTC

When New York attorney general Eric Schneiderman sued Bank of New York Mellon in August, the AG asserted that the Countrywide mortgage-backed securitization trustee had breached its duty to MBS investors. “As trustee, BNYM owed and owes a fiduciary duty of undivided loyalty,” said the AG’s suit, which was filed as a counterclaim in BNY Mellon’s case seeking approval of the proposed $8.5 billion Bank of America settlement with MBS investors. “[BNYM] breached that duty to [investors'] detriment and disadvantage, by failing to notify them of issues regarding the quality of loans underlying their securities.”

But according to BNY Mellon, it had no such duty.

The bank’s lawyers at Mayer Brown and Dechert filed a 14-page brief this week outlining its interpretation of the responsibilities of an MBS securitization trustee. The filing came at the direction of Manhattan federal Judge William Pauley, who’s deciding whether the BofA MBS settlement should be heard in state court, where BNY Mellon filed it, or in federal court, where key objectors to the proposed settlement want it to proceed. Pauley was concerned with the “securities exception” to the Class Action Fairness Act, which could end up guiding his decision on the forum question. For BNY Mellon, however, any discussion of its trustee responsibilities is fraught with danger. It’s already facing the New York AG’s claims, and several other state attorneys general have threatened similar actions. MBS investors, meanwhile, are pushing BNY Mellon (and other securitization trustees) to bring put-back claims, with the implied threat that investors will take action against trustees unless they do.

BNY Mellon’s brief pushes back against that pressure, asserting that the trustee’s responsibilities don’t extend much beyond the ministerial duties spelled out in the pooling and servicing agreements governing MBS trusts. New York law, the filing said, imposes only two addition burdens: the trustee must avoid conflicts of interest and must perform its ministerial functions “with due care.” According to BNY Mellon, there’s an important distinction between ordinary trustees and indenture trustees. Indenture trustees, it said, do not have “a traditional duty of due care.” Its duties — beyond those two basic responsibilities implied in New York law — are strictly defined by the pooling and servicing trust contracts.

Why FHFA IG report doesn’t mean big new liability for banks

Alison Frankel
Sep 27, 2011 21:44 UTC

When I first read the Federal Housing Finance Agency Inspector General’s report criticizing Freddie Mac’s $1.35 billion MBS put-back settlement with Bank of America, I wondered if the FHFA IG had just exposed billions of dollars in untapped bank liability. The IG report notes, after all, that Freddie’s deal with BofA (unlike Fannie Mae’s simultaneous $1.52 billion BofA settlement) resolves not only pending breach of contract claims, but also any future claims that Countrywide breached representations and warranties on the mortgages it sold Freddie. Those are exactly the kinds of global settlements banks are going to have to reach if they have any hope of resolving their MBS put-back liability.

So if the FHFA Inspector General is castigating Freddie for overlooking BofA’s liability for mortgages that defaulted four or five years after they were issued — and FHFA is generally reckoned to be the most experienced evaluator of reps and warranties claims there is — have other put-back claimants underestimated potential bank liability? Are bond insurers and MBS investors making the same supposed mistake as Freddie Mac?

The short answer is no.

The IG report faults Freddie for failing to account for the exotic mortgage loans that proliferated in the housing bubble. Homeowners with interest-only or adjustable-rate mortgages often made it through the early teaser-rate years, only to default when they had to begin making higher payments. The FHFA IG report indicates that Freddie Mac has seen tens of thousands of these mortgages go into default three to five years after they were issued.

Banks beware: Time is ripe for MBS breach-of-contract suits

Alison Frankel
Sep 19, 2011 21:59 UTC

Over the last couple of months Bank of America has taken a stock market and regulatory beating so brutal that it’s reportedly considering the previously unthinkable option of putting Countrywide into Chapter 11. BofA’s mortgage-backed securities exposure seems to have no upper limit; throughout BofA’s long hot summer, it felt like every week investors surfaced with new claims that BofA, Countrywide, or Merrill Lynch violated state and federal securities laws in MBS offerings.

Investors and bond insurers have, of course, made the same claims about Deutsche Bank, Credit Suisse, JPMorgan Chase, Morgan Stanley, Goldman Sachs, and a host of other MBS securitizers. Most notably, the Federal Housing Finance Agency ruined a lot of people’s Labor Day weekend when it filed 17 suits against just about every financial institution in the MBS game (except for Wells Fargo), asserting state and federal securities law claims.

But the difference, so far, between Bank of America and everyone else has been that BofA is facing litigation not just for securities claims but also for breaching contracts with MBS investors. Mortgage-backed securities, remember, were typically sold through trusts governed by pooling and servicing agreements. Those pooling and servicing contracts usually included provisions calling for the originator of the underlying mortgages to repurchase any loans found to violate the lender’s representations and warranties about their quality. Suits based on alleged breaches of reps and warranties are known as put-back claims — and there’s good reason to believe that banks’ put-back exposure may ultimately dwarf their securities law liability.

Grais fights to keep $8.5 billion BofA case in fed. court

Alison Frankel
Sep 15, 2011 20:57 UTC

On Wednesday night, Grais & Ellsworth filed a 29-page brief laying out its arguments for why Bank of America’s proposed $8.5 billion settlement with Countrywide mortgage-backed securities investors belongs in federal court, not in New York state court, where Bank of New York Mellon, as Countrywide MBS trustee, filed it. I’ll talk about Grais’s assertions in a moment, but first I want to explain why the jurisdictional question is so crucial to the ultimate fate of BofA’s proposed deal. Two transcripts tell that tale.

BNY Mellon, you’ll recall, used a highly unusual device when it asked for court approval of the proposed $8.5 billion settlement in late June. The bank filed the case as an Article 77 proceeding in New York state supreme court, taking advantage of a state law that permits trustees to seek a judge’s endorsement of their decisions. Using Article 77 was a deliberate tactic by BNY Mellon, BofA, and the 22 institutional investors who support the settlement. The lawyers who put together the deal considered and rejected other possible vehicles for court approval, but decided that Article 77 was the fastest, cleanest way to resolve claims involving 530 separate trusts. The provision, which is usually invoked in garden-variety trust cases, gives broad discretion to trustees, who are generally assumed to be acting in the best interests of trust beneficiaries.

The Article 77 strategy looked brilliant at the first hearing on the settlement before New York state supreme court judge Barbara Kapnick. According to a transcript of the August 5 hearing, Judge Kapnick shot down objectors to the deal who, in her view, wanted to proceed with discovery as if the case were a class action. “It’s important to remember that this petition was brought as an Article 77 petition,” the judge said. “It’s not a class action. There aren’t provisions in there to opt out that you are talking about. That’s not what this is. If you started it, maybe that’s what you would have done, but they started it and that’s what they did. I have to work, at least now, within the confines of the proceeding that is before me.”

FHFA purposefully vague on Bank of America’s MBS deal?

Alison Frankel
Sep 1, 2011 21:36 UTC

Monitoring the docket Tuesday afternoon, as motions to intervene in Bank of America’s proposed $8.5 billion settlement with Countrywide mortgage-backed securities noteholders piled up, was sort of like watching guests arrive a cocktail party. Oh, here come the hedge funds. Look, there’s a bunch of insurance companies. The public pension funds always head straight for the shrimp. Homeowners? Did anyone invite them? And, of course, Goldman Sachs had to show up fashionably late.

Other party guests may have looked glitzier, but none of Tuesday’s intervention motions is more important to the ultimate determination of the proposed settlement’s fairness than the one filed by the Federal Housing Finance Agency, the government agency that oversees Fannie Mae and Freddie Mac. No one knows the value of mortgage repurchase claims-the claims the proposed BofA deal resolves-better than FHFA.

Here’s why. In the MBS boom years, Fannie Mae and Freddie Mac bought hundreds of billions of dollars of mortgages from Countrywide and many other lenders. The government-sponsored entities packaged the loans into mortgage-backed bonds, just like other MBS issuers. But after the housing bubble burst, and Fannie and Freddie were placed under the federal government’s conservatorship, FHFA had both more of an incentive to get information about those underlying loans than other MBS issuers–and more power to get the information. In July 2010 the agency announced that it had issued 64 subpoenas for mortgage loan documents. Last October it brought in Quinn Emanuel Urquhart & Sullivan to advise on litigation against mortgage lenders that breached representations and warranties about the loans they sold to Fannie and Freddie.

Countrywide MBS investors emerge from shadows as deadline looms

Alison Frankel
Aug 30, 2011 21:44 UTC

Last October, when BofA’s proposed $8.5 billion settlement of Countrywide mortgage-backed securities breach of contract claims was just a twinkle in Kathy Patrick’s eye, David Grais of Grais & Ellsworth told me that one of the biggest problems for lawyers representing disgruntled MBS noteholders was the investors’ reluctance to come forward. Noteholders were afraid to provoke the banks that issued mortgage-backed securities, Grais said, so they didn’t want to sue under their own names. That’s why one of Grais & Ellsworth’s early put-back cases was filed on behalf of an ad hoc coalition of anonymous Countrywide MBS investors operating under the name Walnut Place.

It’s also why the Gibbs & Brun investor group that negotiated the BofA deal made such a splash. Kathy Patrick’s big institutional investor clients, including Pimco, BlackRock, and the New York Federal Reserve’s Maiden Lane funds, showed their faces when they offered public support for the proposed $8.5 billion settlement. In fact, after Grais’s Walnut Place investors filed an objection to the proposed deal, supporters of the settlement drew a contrast between the Gibbs group’s public face and Walnut’s anonymity.

But as time runs out for investors to claim a place in the litigation over the proposed settlement, more and more Countrywide MBS noteholders are shrugging off secrecy. On Monday, six new interventions motions appeared in either the original state court docket or in federal court, where Grais & Ellsworth removed the case last week. (A seventh intervention petition, by American Fidelity Assurance, popped up Tuesday morning.) The big news was the placeholder petition Grais filed on behalf of the Federal Deposit Insurance Corporation, which says it is “the receiver of numerous banks and owner of many certificates issued by many of the trusts that would be covered by the proposed settlement.” (Hard to know from that how big a stake the FDIC has in the Countrywide MBS offerings.) Like the six Federal Home Loan Banks that have already intervened in the proposed settlement, the FDIC isn’t yet objecting to the deal, but said it wants more information to evaluate the fairness of the deal.

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