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MBIA Corp. (MBI) is well poised to win its three year old lawsuit against Countrywide Financial, a subsidiary of Bank of America Corporation (BAC). The positive development in the case comes from the New York judge’s ruling.

According to the ruling, MBIA is not required to justify that misrepresentations made by Countrywide regarding the nature of its securities led to billions of claims payment by the former. The fact that MBIA Corp was misled is enough to tilt the scales in its favor.

The potential cost of recent charges against BofA could be as high as $2 billion. However, it is also assumed that this $2 billion settlement will offset the claim made by BofA against MBIA back in 2009 for its restructuring.

The Story Behind

It all started before the starting of financial crisis in 2008. Though MBIA mainly focuses on municipal bonds, it guaranteed and sold a large number of credit-default swaps (“CDS”) on commercial mortgage backed security (“CMBS”) and other structured financial products during the boom of U.S. real estate market.

MBIA had then provided insurance coverage on Countrywide’s securities worth $20 billion. These securities were backed by Countrywide loans made between 2005 – 2007, at a time when the housing market was flourishing. However, it was also a time when manipulation was pervasive in the industry.

The securities were riskier than what Countrywide had disclosed. MBIA guaranteed payment, assured of the credibility of the disclosures made by the lender. However, the loans soured when the housing market collapsed, triggering billion of dollars in claim payments by MBIA. Consequently, MBIA sued Countrywide, alleging fraud, misrepresentation and breach of contract. 

Going further, the housing market collapse triggered MBIA’s CDS default and the huge claims threatened its profits. Hence in 2009, MBIA decided to split itself in to two units – a municipal guarantee business and a structured finance unit. However, a group of 18 banks, including Bank of America, objected to the restructuring and claimed that MBIA’s ability to pay its policyholders will get reduced in the event of a split in its business.

However, in the past year, several banks have dropped their lawsuits after MBIA reached a settlement with them. While last month Morgan Stanley withdrew its objection for restructuring and settling the legal charges, UBS AG (UBS), Societe Generale Group, Natixis and BNP Paribas (BNP) still remain under the original lawsuit. Thus a total of 13 banks have reached an agreement with MBIA.

Other than Countrywide, MBIA has filed mortgage put-backs litigation against four other financial institutions who defrauded it. The trial against Ally Bank subsidiary, RFC, is scheduled to start this year. MBIA has paid billions in claims on securitizations, sponsored by these five institutions. However, the insurer expects full recovery of the amounts, contractually, due to it as well as significant damages for each of these actions.

Litigation, negotiated settlements of credit derivative transactions and a significant reduction in direct residential mortgage-backed securities (RMBS) claims payment were the main themes for MBIA Insurance Corporation in 2011. 

For a long time, MBI’s share price has been sensitive to the outcomes of its lawsuits. The favorable ruling by the judge helped the stock to jump 8.1%, we expect a good bounce in MBI stock price if the case settles in its favor.

 
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