Banks sue MBIA over split

Bloomberg is reporting that 18 banks have sued MBIA over its split:

Bank of America Corp., JPMorgan Chase & Co., UBS AG and 15 more of the world’s largest financial companies sued MBIA Inc., saying the biggest bond insurer’s split of its guarantee business illegally cut their odds of getting paid on policies.

MBIA stripped $5 billion of assets out of its MBIA Insurance Corp. division to fund a new unit amid “an ongoing financial crisis that has made it increasingly likely that MBIA Insurance will have to pay out billions” of dollars, according to the complaint filed today in New York State Supreme Court in Manhattan.

The case adds to two previous lawsuits filed by funds over the February restructuring by Armonk, New York-based MBIA, which New York State Insurance Superintendent Eric Dinallo approved. Banks concerned that the split of the business hurt them had met with state regulators in March, David Neustadt, a spokesman for the New York State Insurance Department, said at the time.

The decision to move assets from the unit and “render it effectively insolvent was a blatant attempt to enrich MBIA Inc. and its management at the expense of MBIA Insurance and its policyholders,” Vince DiBlasi, a lawyer who represents the group at Sullivan & Cromwell LLP, said in an e-mailed statement.

The group also includes Barclays Plc, HSBC Holdings Plc, Citigroup Inc., Canadian Imperial Bank of Commerce, BNP Paribas, Royal Bank of Canada, Morgan Stanley, Sumitomo Mitsui Financial Group Inc., Societe Generale, Credit Agricole SA and Wells Fargo & Co. or their units.

MBIA decided to split itself into a business that writes muni bond insurance and another that, in the past, wrote structured finance product insurance. The split is thought to strengthen the muni bond business at the expense of the other. Banks and various other sophisticated parties seem to be the only buyers of the structured product insurance. The lawsuits aren't a surprise but it remains to be seen what comes of all this. The insurance regulator approved the split but I'm not sure what the courts will think of this.

Funds such as Martin Whitman's Third Avenue Fund has also sued MBIA over the split. In this case, the concern by Third Avenue is that the debt-like notes purchased by Third Avenue will have less assets backing it.

In the same article, MBIA says it is vigorously pursuing lawsuits against various banks and others involved in packaging mortgage securities:

Brown said on a conference call yesterday that about 66 percent to 80 percent of his insurer’s losses on second-mortgage bonds and mortgage-related collateralized debt obligations, its two worst insurance categories, are tied to collateral that was “ineligible” to be included in the deals, and so its guarantee payouts may be recouped, either through negotiations or suits.

Again, it's not clear how the courts will rule. A lot of the court rulings related to the monolines will likely have huge ramifications for the entire real estate securitization industry, going all the way from the mortage lenders, to banks, to investors. For instance, if a monoline wins a court case by showing fraudulent actions during secrutization (admittedly a tall order,) it's possible—I'm not a lawyer and this is pure layperson speculation—that investors who purchased similar securities may be able to sue banks arguing that the securities they purchased were misrepresented. Most mortage lenders are bankrupt or defunct now, so the ones that may be vulnerable to damage claims will be the packagers of mortgage securities, who were mostly investment banks and very large commercial banks. Overall, any damage payments, assuming any of this even happens, is likely to be limited since the two biggest real estate securities players, Bear Stearns and Lehman Brothers, aren't alive anymore (I'm not sure if JP Morgan has exposure to Bear Stearns' legacy operations or if it is shielded.)

Not to be outdone, MBIA has also offered to buy back its insurance company preferred shares for 10 cents on the dollar.