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MBIA Fights Banks for Its Life
By FLOYD NORRIS
MBIA, an insurance company whose very existence is imperiled because it underestimated the risks involved in mortgage lending, says the banks owe it billions because they lied about the mortgages backing securities that MBIA insured. The insurer’s financial statements show it is solvent in large part because that money will be coming in.
The banks disagree. Their financial statements reflect no such obligation.
Just who is right will be determined over time, by courts and by negotiations. It is unlikely that much more will be known before annual reports come out this spring, but pressure is building on both sides to provide more complete disclosure of possible outcomes, and of how they reached their conclusions.
In the meantime, many of the same banks being sued by MBIA are trying to persuade a judge that the company is now and has been insolvent for a couple of years. That case was supposed to come to trial this month, but it has been delayed in part by the refusal of the New York State Insurance Department, MBIA’s regulator, to let a judge see e-mails between department officials when the department was approving a plan that reorganized MBIA in ways that left some MBIA-insured policyholders — notably banks — less likely to be paid if there are defaults.
In the last couple of weeks, two seemingly contradictory verdicts were rendered on MBIA’s health. First, Standard & Poor’s downgraded MBIA’s bond rating to the lower regions of junk, warning that the company’s “capital adequacy is very weak,” although it did have enough assets to meet all claims for at least a few years. Then the stock leaped 35 percent over five trading days.
The apparent cause for the increase was the disclosure that three banks — JPMorgan Chase, Barclays and Royal Bank of Canada — had withdrawn from the suit challenging the insurance department approval of the MBIA reorganization. It seems unlikely that that in itself would be very important, since the other banks seem committed to pursuing the case. The banks are not seeking damages, just a reversal of the reorganization, so the number of plaintiffs is important only in determining who shares the costs of the case.
But there also is speculation that MBIA and the banks that withdrew from the suit reached other deals that could bolster MBIA’s position. Did the banks agree to pay some of the money MBIA says it is owed? If so, that could go a long way toward validating MBIA’s decision to book $2.2 billion in payments from the banks, even though up until now it has reached only one settlement, and that for an amount so small that the company deemed it immaterial.
Alternatively, did one or more of the banks reach an agreement on policy commutations? In such a deal, the beneficiary of insurance — in this case the banks as owners of securities insured by MBIA — agree to accept a payment now in return for canceling the insurance. That could provide evidence that MBIA’s eventual exposure will not be as great as S.& P. feared when it cut the bond rating of MBIA Inc., the parent company, to B-minus.
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The stock market reaction would seem to indicate that whatever happened may have been material, but neither the banks nor MBIA will say if any other agreements were reached, but MBIA disclosed this week that it had dropped a lawsuit claiming it was defrauded by Royal Bank. MBIA says it will have something to say on March 1, when it releases its annual financial statements.
All of this stems from the run-up to the financial crisis, when no one took steps that could have halted irresponsible lending before it rose to crisis proportions. Instead, everyone involved thought it profitable to assume that all was well and to book immediate profits. The banks making the bad loans sold them off in securitizations.
The rating agencies gave AAA ratings to securities without actually looking at the loans. MBIA and its competitors insured the securities without bothering to look at the loans. Now MBIA claims that the banks defrauded it because many of the loans did not meet the stated underwriting criteria. Institutional investors — among them banks themselves — bought the securities without doing much homework either.
One disclosure in MBIA’s third-quarter filing with the Securities and Exchange Commission provides an insight into just how fictional those ratings were on the most exotic securities, what are known as multisector collateralized debt obligations, or C.D.O.’s. and C.D.O.-squareds. A C.D.O. is backed by securities that are backed by actual loans. A C.D.O.-squared is backed by securities that are backed by securities that are backed by actual loans.
MBIA said that 99 percent of such securities that it insured were rated AAA at issuance, with the remainder rated AA, also a very high rating. Now 1 percent are rated AAA and another 7 percent have lesser investment grade ratings. The remaining 92 percent have junk bond ratings. MBIA insured $18 billion in such securities, and now expects to pay $2.3 billion in claims, an amount it says “could increase materially.”
The outlook seems to have been getting worse, but that has not been reflected in MBIA’s balance sheet. In the third quarter of last year, the company concluded that it would have to pay out $107 million more than it had expected on insured securities backed by residential mortgages. But its expected loss on such securities fell. How could that be? It was simple: the company increased the amount it expected to get from the banks.
The differing views of what will be paid have raised eyebrows both at the S.E.C. and at the Public Company Accounting Oversight Board, which regulates auditors. The S.E.C., in letters to financial institutions, warned in October that an accounting rule “requires you to establish accruals for litigation and other contingencies when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.” Even if those criteria are not met, “disclosure of the contingency is required to be made when there is at least a reasonable possibility that a loss or an additional loss has been incurred,” the S.E.C. added.
Last month the accounting board followed up with a message to auditors warning that there was a “risk of material misstatement” in financial statements, in part because of litigation over mortgage securitizations.
Warnings to accountants cannot produce certainty when there is none, even if they can produce better disclosures regarding the range of possibilities. Much hinges on just how big the losses from bad mortgages are going to be. MBIA thinks S.& P.’s fears regarding its capital are based on assumptions that the losses could be much larger than they actually will be. Given how badly S.& P. once underestimated the risks, it is certainly possible that it is now overestimating them. But the opposite is also possible.
MBIA’s hopes of going back into the business of writing new policies are based on its reorganization — or transformation, as the company calls it — which split its existing policies into two groups. One, covering municipal bonds issued by American state and local government agencies, still has the support of all of MBIA’s assets. The other, covering foreign bonds and all structured finance transactions, is backed by only some of the assets.
The New York State Insurance Department concluded that both parts would be solvent, and authorized the complex arrangement. The fact the company had made a detailed proposal was not disclosed to the public until after it was approved in early 2009.
In reaching its decision, the department made clear that it was trying to keep muni bond insurance available. The case pending in New York State court challenges the department approval, claiming it was arbitrary and capricious.
The judge hearing the case ordered the department to turn over to a hearing officer all e-mail regarding the deal sent by five department officials to each other in the two months before the transaction was approved. The hearing officer is supposed to look for evidence of bias and, if he finds any, turn those e-mails over to the banks. This week the New York attorney general’s office, which is representing the department, notified the court it wanted to appeal that order and keep the documents secret. It said such disclosures would be unprecedented and could harm the department’s ability to have frank internal discussions in future cases.
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Officials from the insurance department and the state attorney general’s office refused to discuss the issue this week, but Robert J. Giuffra Jr., a partner in Sullivan & Cromwell who is representing the banks, was happy to do so. “They seem to be fighting hammer and tong to avoid any public disclosure of the internal basis of their decision,” he said, adding that the banks believed they could prove that MBIA was insolvent and that the regulator’s “so-called thorough review was window dressing.”
MBIA will not be able to write new muni bond insurance unless and until the reorganization survives legal challenge. The company had hoped to have a ruling by now, but further delays seem inevitable. This week the judge hearing the case, James A. Yates, announced he was leaving the bench to become counsel to the speaker of the New York Assembly, Sheldon Silver. It will take time for a new judge to understand the facts in the case. At MBIA, the tone is upbeat. Last spring, when the stock price was under pressure, the company resumed its stock repurchases, and through October had spent $28 million buying back shares. That is not a lot of money for a company with billions in assets, but MBIA is also a company whose most recent balance sheet would have shown no net worth had it not been able to book the expected payments from the banks and deferred tax assets whose value will be realized only after the company returns to profitability and is able to avoid paying taxes on those profits.
“Our continued solvency and payment of all claims and obligations since our transformation confirms that the New York State Insurance Department was correct in concluding that the transformation was fair and equitable to all policyholders and fully consistent with New York insurance law,” Jay Brown, the company’s chief executive, said in a statement.
http://www.nytimes.com/2011/01/07/bu...1&ref=business
By FLOYD NORRIS
MBIA, an insurance company whose very existence is imperiled because it underestimated the risks involved in mortgage lending, says the banks owe it billions because they lied about the mortgages backing securities that MBIA insured. The insurer’s financial statements show it is solvent in large part because that money will be coming in.
The banks disagree. Their financial statements reflect no such obligation.
Just who is right will be determined over time, by courts and by negotiations. It is unlikely that much more will be known before annual reports come out this spring, but pressure is building on both sides to provide more complete disclosure of possible outcomes, and of how they reached their conclusions.
In the meantime, many of the same banks being sued by MBIA are trying to persuade a judge that the company is now and has been insolvent for a couple of years. That case was supposed to come to trial this month, but it has been delayed in part by the refusal of the New York State Insurance Department, MBIA’s regulator, to let a judge see e-mails between department officials when the department was approving a plan that reorganized MBIA in ways that left some MBIA-insured policyholders — notably banks — less likely to be paid if there are defaults.
In the last couple of weeks, two seemingly contradictory verdicts were rendered on MBIA’s health. First, Standard & Poor’s downgraded MBIA’s bond rating to the lower regions of junk, warning that the company’s “capital adequacy is very weak,” although it did have enough assets to meet all claims for at least a few years. Then the stock leaped 35 percent over five trading days.
The apparent cause for the increase was the disclosure that three banks — JPMorgan Chase, Barclays and Royal Bank of Canada — had withdrawn from the suit challenging the insurance department approval of the MBIA reorganization. It seems unlikely that that in itself would be very important, since the other banks seem committed to pursuing the case. The banks are not seeking damages, just a reversal of the reorganization, so the number of plaintiffs is important only in determining who shares the costs of the case.
But there also is speculation that MBIA and the banks that withdrew from the suit reached other deals that could bolster MBIA’s position. Did the banks agree to pay some of the money MBIA says it is owed? If so, that could go a long way toward validating MBIA’s decision to book $2.2 billion in payments from the banks, even though up until now it has reached only one settlement, and that for an amount so small that the company deemed it immaterial.
Alternatively, did one or more of the banks reach an agreement on policy commutations? In such a deal, the beneficiary of insurance — in this case the banks as owners of securities insured by MBIA — agree to accept a payment now in return for canceling the insurance. That could provide evidence that MBIA’s eventual exposure will not be as great as S.& P. feared when it cut the bond rating of MBIA Inc., the parent company, to B-minus.
•
The stock market reaction would seem to indicate that whatever happened may have been material, but neither the banks nor MBIA will say if any other agreements were reached, but MBIA disclosed this week that it had dropped a lawsuit claiming it was defrauded by Royal Bank. MBIA says it will have something to say on March 1, when it releases its annual financial statements.
All of this stems from the run-up to the financial crisis, when no one took steps that could have halted irresponsible lending before it rose to crisis proportions. Instead, everyone involved thought it profitable to assume that all was well and to book immediate profits. The banks making the bad loans sold them off in securitizations.
The rating agencies gave AAA ratings to securities without actually looking at the loans. MBIA and its competitors insured the securities without bothering to look at the loans. Now MBIA claims that the banks defrauded it because many of the loans did not meet the stated underwriting criteria. Institutional investors — among them banks themselves — bought the securities without doing much homework either.
One disclosure in MBIA’s third-quarter filing with the Securities and Exchange Commission provides an insight into just how fictional those ratings were on the most exotic securities, what are known as multisector collateralized debt obligations, or C.D.O.’s. and C.D.O.-squareds. A C.D.O. is backed by securities that are backed by actual loans. A C.D.O.-squared is backed by securities that are backed by securities that are backed by actual loans.
MBIA said that 99 percent of such securities that it insured were rated AAA at issuance, with the remainder rated AA, also a very high rating. Now 1 percent are rated AAA and another 7 percent have lesser investment grade ratings. The remaining 92 percent have junk bond ratings. MBIA insured $18 billion in such securities, and now expects to pay $2.3 billion in claims, an amount it says “could increase materially.”
The outlook seems to have been getting worse, but that has not been reflected in MBIA’s balance sheet. In the third quarter of last year, the company concluded that it would have to pay out $107 million more than it had expected on insured securities backed by residential mortgages. But its expected loss on such securities fell. How could that be? It was simple: the company increased the amount it expected to get from the banks.
The differing views of what will be paid have raised eyebrows both at the S.E.C. and at the Public Company Accounting Oversight Board, which regulates auditors. The S.E.C., in letters to financial institutions, warned in October that an accounting rule “requires you to establish accruals for litigation and other contingencies when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.” Even if those criteria are not met, “disclosure of the contingency is required to be made when there is at least a reasonable possibility that a loss or an additional loss has been incurred,” the S.E.C. added.
Last month the accounting board followed up with a message to auditors warning that there was a “risk of material misstatement” in financial statements, in part because of litigation over mortgage securitizations.
Warnings to accountants cannot produce certainty when there is none, even if they can produce better disclosures regarding the range of possibilities. Much hinges on just how big the losses from bad mortgages are going to be. MBIA thinks S.& P.’s fears regarding its capital are based on assumptions that the losses could be much larger than they actually will be. Given how badly S.& P. once underestimated the risks, it is certainly possible that it is now overestimating them. But the opposite is also possible.
MBIA’s hopes of going back into the business of writing new policies are based on its reorganization — or transformation, as the company calls it — which split its existing policies into two groups. One, covering municipal bonds issued by American state and local government agencies, still has the support of all of MBIA’s assets. The other, covering foreign bonds and all structured finance transactions, is backed by only some of the assets.
The New York State Insurance Department concluded that both parts would be solvent, and authorized the complex arrangement. The fact the company had made a detailed proposal was not disclosed to the public until after it was approved in early 2009.
In reaching its decision, the department made clear that it was trying to keep muni bond insurance available. The case pending in New York State court challenges the department approval, claiming it was arbitrary and capricious.
The judge hearing the case ordered the department to turn over to a hearing officer all e-mail regarding the deal sent by five department officials to each other in the two months before the transaction was approved. The hearing officer is supposed to look for evidence of bias and, if he finds any, turn those e-mails over to the banks. This week the New York attorney general’s office, which is representing the department, notified the court it wanted to appeal that order and keep the documents secret. It said such disclosures would be unprecedented and could harm the department’s ability to have frank internal discussions in future cases.
•
Officials from the insurance department and the state attorney general’s office refused to discuss the issue this week, but Robert J. Giuffra Jr., a partner in Sullivan & Cromwell who is representing the banks, was happy to do so. “They seem to be fighting hammer and tong to avoid any public disclosure of the internal basis of their decision,” he said, adding that the banks believed they could prove that MBIA was insolvent and that the regulator’s “so-called thorough review was window dressing.”
MBIA will not be able to write new muni bond insurance unless and until the reorganization survives legal challenge. The company had hoped to have a ruling by now, but further delays seem inevitable. This week the judge hearing the case, James A. Yates, announced he was leaving the bench to become counsel to the speaker of the New York Assembly, Sheldon Silver. It will take time for a new judge to understand the facts in the case. At MBIA, the tone is upbeat. Last spring, when the stock price was under pressure, the company resumed its stock repurchases, and through October had spent $28 million buying back shares. That is not a lot of money for a company with billions in assets, but MBIA is also a company whose most recent balance sheet would have shown no net worth had it not been able to book the expected payments from the banks and deferred tax assets whose value will be realized only after the company returns to profitability and is able to avoid paying taxes on those profits.
“Our continued solvency and payment of all claims and obligations since our transformation confirms that the New York State Insurance Department was correct in concluding that the transformation was fair and equitable to all policyholders and fully consistent with New York insurance law,” Jay Brown, the company’s chief executive, said in a statement.
http://www.nytimes.com/2011/01/07/bu...1&ref=business
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