Alison Frankel

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.

Reporting on the implications of the bond insurer Syncora’s $375 million settlement with Bank of America has been a Rashomon experience: Everyone I talked to had something different to say about what drove Tuesday’s settlement and what it means for MBIA, which has been litigating its own mortgage-backed securities breach-of-contract claims in parallel with Syncora. So if you were expecting a clear-cut answer on whether the Syncora settlement is good or bad for MBIA, you’re going to be disappointed. Syncora and MBIA were both litigating put-back claims against Countrywide and BofA before New York State Supreme Court Justice Eileen Bransten, who has delivered important simultaneous rulings for the bond insurers. But the similarities between Syncora and MBIA end in Bransten’s courtroom. When it comes to negotiations with BofA, they’re in very different postures.

The good news for MBIA: Bank of America’s settlement with Syncora shows that the bank remains willing and able to resolve claims that the mortgages underlying Countrywide-sponsored securities breached representations and warranties. In 2010 and 2011 Bank of America reached reps-and-warranties deals with the bond insurer Assured Guaranty; with the government-sponsored entities Fannie Mae and Freddie Mac; and with 22 institutional investors who backed a global $8.5 billion settlement of MBS investors’ put-back claims. Since then, the bank has been stuck in litigation with objectors to the proposed $8.5 billion global deal and in sniper fire with Fannie Mae. The Syncora settlement puts BofA back on the settlement track.

The settlement also shows that momentum from the litigation helps the monolines. My understanding is that Syncora and Bank of America have been in settlement talks for a long time, negotiating behind the curtain while the litigation plays out on a public stage. Specific events in the monoline cases against the banks – even developments as significant as Bransten’s loss-causation ruling or the battle over Bank of America’s successor liability for Countrywide’s wrongdoing – don’t have a direct impact on negotiations. That said, when U.S. District Judge Paul Crotty of Manhattan delivered a very insurer-friendly ruling on loss causation last month in Syncora’s case against JPMorgan, BofA took note. That’s also a positive for MBIA.

Bank of America really, really does not want CEO Brian Moynihan to sit for a deposition in bond insurer MBIA’s breach-of-contract case against Countrywide and BofA.

According to the transcript of a hearing on the issue last Friday morning before Manhattan State Supreme Court Justice Eileen Bransten, the bank’s lawyers at O’Melveny & Myers said that under the so-called Apex rule — which essentially says that high-ranking executives shouldn’t have to waste their time responding to deposition questions that lesser-ranking officials can answer just as well — Moynihan should be shielded from testifying because he doesn’t have unique personal knowledge of the disputed facts in the case. He’s also a very busy man, said Jonathan Rosenberg of O’Melveny. Rosenberg displayed a slide that showed all of BofA’s “enormous operations,” which he said demanded “24/7 work from senior executives, especially the CEO.” MBIA’s insistence on taking testimony from Moynihan, when BofA has already offered up for deposition several senior bank executives with the same knowledge as the CEO, amounts to harassment, according to BofA.

“There’s no basis to say they have to have Brian Moynihan when they have access to all these other people,” including former BofA CEO Ken Lewis, Rosenberg said. “This effort to depose Brian Moynihan is for harassment purposes.” If Bransten allowed the deposition in MBIA’s case, other bond insurers suing Countrywide would “seek their own shot,” the O’Melveny lawyer said, which “would clearly be disruptive to the business of Bank of America to lose their CEO to substantial time in prepping for and taking depositions.”

The megabillion-dollar game of chicken between Bank of America and the bond insurer MBIA just got even more perilous. On Monday MBIA filed a notice that it is cross-appealing the ruling by Manhattan State Supreme Court Justice Eileen Bransten. MBIA wants reconsideration of Bransten’s finding that the bond insurer is not entitled to summary judgment on its claims that Countrywide breached representations and warranties on the mortgage-backed securities MBIA agreed to insure. You might think MBIA’s decision to appeal is a surprise, given the many routes to recovery Bransten gave MBIA on its insurance fraud claims against Countrywide. But as always in the incredibly complex litigation between Bank of America and MBIA, there are many layers to every move by either side.

Bransten’s rulings were undoubtedly a boon for the monolines Syncora and MBIA. The judge said the bond insurers don’t have to establish a direct causal link between the alleged deficiencies in the mortgage loans underlying the securities they agreed to insure and the subsequent payouts the insurers had to make on those MBS policies. Under Bransten’s opinion, MBIA and Syncora can prove insurance fraud merely by establishing that they relied on Countrywide’s alleged misrepresentations when they agreed to write the policies at issue in the litigation. And to prove a breach of the insurance agreements, they need only prove that Countrywide materially misrepresented the risk profile of the underlying mortgage pools.

Nevertheless, two days after Bransten issued her opinion, Syncora’s lawyers at Debevoise & Plimpton filed a notice of appeal. That’s because the decision wasn’t all good news for the monolines: Bransten denied Syncora and MBIA summary judgment on their interpretation of the MBS contracts they signed with Countrywide. The monolines argued that Countrywide was required to buy back every underlying mortgage that didn’t live up to the representations and warranties the issuer made about the mortgage pool. Bransten, however, said the contract language was too ambiguous for the issue to be decided on summary judgment. Syncora said it was seeking a reversal of that part of the ruling.

Tuesday’s parallel rulings by Manhattan State Supreme Justice Eileen Bransten in MBIA and Syncora suits against Countrywide were a big win for the bond insurers. The judge concluded that MBIA and Syncora need only show that Countrywide materially misled them at the time they agreed to write insurance on Countrywide mortgage-backed notes, not that the alleged misrepresentations led directly to MBS defaults and subsequent insurance payouts. Bransten is considered a leading judge on MBS issues, so her grant of summary judgment on the insurance fraud and contract issues should be a boon to all of the monolines engaged in do-or-die litigation with MBS issuers.

But for MBS investors hoping Bransten would set a low bar for claims that Countrywide breached mortgage-backed securitization agreements, the rulings have to be considered a disappointment. Both Syncora’s lawyers at Debevoise & Plimpton and MBIA’s counsel at Quinn Emanuel Urquhart & Sullivan had moved for summary judgment on a baseline question: could they demand that Countrywide repurchase any underlying mortgage loan that materially breached the MBS issuer’s representations and warranties in securitization agreements?

If Bransten had agreed with the Syncora and MBIA interpretations of the agreements’ put-back clauses, the bond insurers would have had to show only that an underlying loan was deficient, not that the alleged deficiency contributed to the mortgage’s default — or, for that matter, that the underlying loan even was in default. The insurers wanted the judge to rule that as a matter of contract, Countrywide was required to repurchase every flawed mortgage in underlying pools.

There’s a cautionary note to MBIA deep in Manhattan State Supreme Court Justice Eileen Bransten‘s long-awaited, 27-page loss-causation decision in MBIA’s mortgage-backed securities case against Countrywide. The bond insurer, Bransten warned, must prove that it was damaged as a “direct result” of Countrywide’s allegedly material misrepresentations about the MBS certificates MBIA agreed to insure. “As has been aptly pointed out by Countrywide, this will not be an easy task,” the judge wrote.

But unless I am seriously misreading Bransten’s ruling (and her companion decision in Syncora’s case) it’s going to be a lot easier for the bond insurers to recover against Countrywide as a result of the judge’s reasoning. Yes, MBIA and Syncora have to prove they were duped into writing insurance policies on Countrywide mortage-backed securities. The monolines have never asserted that they don’t have to show Countrywide made material misrepresentations at the time they agreed to issue insurance. They believe they’ve got plenty of evidence — from the MBS pooling and servicing agreements, from the loan tapes they were permitted to see, and from the shadow credit ratings conferred on the MBS notes — that Countrywide misled insurers about the quality of the mortgages in the underlying loan pools.

Instead, the key question before Bransten was whether the insurers would also have to show that Countrywide’s alleged misrepresentations were the direct cause of the MBS failures for which insurers had to pay out policy claims. And on this issue, the judge sided squarely with the monolines. “No basis in law exists to mandate that MBIA establish a direct causal link,” she concluded.

The folks who follow every development in the mega-billions poker match between Bank of America and the bond insurer MBIA have last week been buzzing even more loudly than usual about the prospect of a global deal. Tuesday’s settlement between MBIA and Morgan Stanley leaves BofA as the most important remaining member of the dwindling bank group challenging MBIA’s 2009 restructuring. There’s a de facto deadline of Dec. 30 for settlements in that case, since that’s the day New York’s top financial regulator, Benjamin Lawsky of the Department of Financial Services, has to file a key response to the banks’ allegations. Both Lawsky and MBIA execs have been very clear: they want resolution. So the pressure is on BofA to make a deal.

Moreover, MBIA really needs a global settlement with BofA, in which the bank not only drops out of the restructuring case but also ponies up to resolve the bond insurer’s mortgage-backed securities claims. MBIA filed an 8K with the Securities and Exchange Commission Thursday, disclosing the good news that its commutation deals have wiped out $20 billion in exposure, including more than $10 billion its has eliminated just in the fourth quarter of 2011. The bad news in the filing, however, is that MBIA’s payments to banks have exceeded its statutory loss reserves by $500 million, and the insurer may not have enough liquidity to reach more settlements. Remember, MBIA has already booked a $2.8 billion anticipated recovery on MBS put-back claims. Clearly, the bond insurer is counting on getting some big money from BofA on the MBS side.

The wild card in this poker game is loss causation and MBS liability for BofA (and other issuers). You’ll recall that in early October, New York State Supreme Court Justice Eileen Bransten heard arguments on a summary judgment motion by MBIA in its case against Countrywide. MBIA asked the judge to rule on the issue that will determine the magnitude of bank exposure to MBS claims by bond insurers: are the banks liable for misrepresenting the underwriting on loans in underlying mortgage pools starting from the day they signed deals with monoline insurers? Or can the banks cite the economic crisis — and not their own deficient underwriting — as the reason so many mortgage loans have gone bad? Bransten’s reasoning on loss causation could swing billions, or even tens of billions, of dollars of liability between the banks and the monolines.

Last month, as U.S. banks began reporting their third-quarter financials, I noted that the banks had beefed up their disclosure of potential liability for mortgage-backed securities activity. Morgan Stanley revealed that it had received a demand letter from Gibbs & Bruns, the firm that represents the big funds that negotiated the proposed $8.5 billion MBS breach-of-contract settlement with Bank of America. Goldman upped its reported MBS exposure to $15.8 billion, from a mere $485 million in the second quarter. The new emphasis on disclosure, I said, was partly the result of more claims, but also partly due to pressure from the Securities and Exchange Commission and the Public Company Accounting Oversight Board to improve MBS disclosures.

The bond insurers’ trade group, the Association of Financial Guaranty Insurers, has also been agitating for banks to acknowledge their MBS exposure — and particularly their exposure to MBS breach-of-contract (or put-back) claims. In September 2010 AFGI sent a blistering letter asserting that Bank of America’s MBS put-back liability to its members was more than $10 billion. This September the bond insurers targeted Credit Suisse, which, according to AFGI, had failed to account for billions in put-back claims.

Late Wednesday AFGI struck again. The recipient this time was UBS. According to the letter AFGI sent to UBS CEO Sergio Ermotti, the Swiss bank has reported a $93 million reserve for put-back claims in its most recent financial report — even though it has received more than $800 million in put-back claims from just one bond insurer, and that insurer (presumably Assured Guaranty) has indicated its intention of demanding a total of $4 billion in put-backs from UBS.

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.