Thursday, January 6, 2011

Commutation Settlements - Jay Told Us!

On Nov. 9, MBIA held their conference call in which Jay Brown, MBIA CEO said:

"First, we had a significant commutation of $4.4 billion of par reduction for approximately $70 million going out the door. We announced last quarter that $2.9 million was done immediately. It's now been completed in the $4.4 billion of exposures left to our books."

This is from Bloomberg today:

"MBIA had sued RBC in January 2010 over $4.4 billion of credit-default swaps the insurer sold the bank to protect against losses on three collateralized debt obligations created and marketed by RBC, according to a copy of the complaint on MBIA’s website."

So this is how some reporter felt when she put together Assange's bank dump and the year-earlier B of A computer disclosure right before that combination became news 24 hours later. This evening, The Bond Buyer also reported that MBIA could not discuss a settlement involving S.F., Asian Art Museum, and JP Morgan due to a non-disclosure agreement. Such a non-disclosure agreement could be part of the larger JP Morgan settlement involving a commutation.

But Jay continued:

"There are no other commutations that we are going to announce today, although I do expect that you're going to see a number of them occur in the fourth quarter, which we'll discuss approximately 90 days from now."

Jay told us these were coming and they came. These are undoubtedly very large or global settlements.

Accounting Wonders

There has been a well publicized mismatch in reserves between financial guarantors and the banks they are suing. By commuting the deals as part of the settlement, the accounting could become even more alchemical in that both sides may be able to book gains or limit losses. While the banks have little or no litigation or putback loss reserves, they may have a large writedown on the payoffs of insurance policies due to MBIA Corp's poor credit. MBIA meanwhile has no such writedown in its operating book value, operating income, or statutory financial statements. This creates a large area for both sides to claim accounting victory.

Furthermore, MBIA has not booked any benefit for CDO recoveries (as mentioned in prior posts), so any benefit would drop straight to equity through income.

They Were Good Deals

Management indicated that these deals were advancing as of the Q3 call, slightly before MBIA's stock purchase window opened. MBIA's stock fell from $13.17 to below $10 in November at which time Jay Brown bought 100,000 more shares bringing his total ownership to roughly 4M shares or 2% of the company. Now let's ask the audience: do you think they are good deals?

JP Morgan has been credited with a more conservative reserve for its exposure compared with its peers. That they are among the deal makers should be unsurprising and indicative of the notional value exchanged. The term notional exchange is meant to de-emphasize the transfer of cash in these multi-faceted deals. MBIA could theoretically send cash out the door net on these deals and still record very positive reserve benefits.

B of A's recent deal insisted they materially settled their putback exposure with the GSEs for a $3B cash payment. However, B of A already had well over $3B in reserves for that exposure and booked an additional $3B of loss expense in the quarter implying the GSE exposure would cost them over $6B for Q4 and beyond. Similarly the $2B goodwill writedown could be an admission that future losses on other exposure could overwhelm the legacy Countrywide units profitability.

B of A CEO Brian Moynihan has previously claimed mortgage putback claims would be fought one-by-one after Judge Bransten said "Its going to be a sample." This may have been unsettling for well-informed investors fearful of dishonest or misinformed executives.

I'm Back

Leadership shows us that intangible assets can contain real value. Jay Brown is showing us that litigation recoveries are no exception. According to MBIA employees, Brown wrote a message to his relatively small company upon his return to his former post. It began with "I'm back." MBIA's Q4 conference call may carry the message of "We're here to stay." Meanwhile, Brown may prove the real value of leadership again.

(Updated 1/7 12:33 AM EST U.S. to include Asian Art Museum settlement.)

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