The government is looking to jump-start the
securitization market through its Term Asset-Backed Securities Loan
Facility (TALF) and has some funds and other investors positively
gleeful at the promised benefits. Beware one and all -- the ghost of
securitizations-past still hangs over, and current litigations are
living proof. In particular, underlying asset originators and credit
enhancement firms must be careful about their roles. TALF
may not solve all of their ills. Furthermore, with the just-announced
lawsuit against MBIA's securitization-driven restructuring, it's clear
that the hot-seat role of credit enhancer has become even hotter.
As background, securitization is the process of repackaging financial
assets (no matter how dodgy those assets are individually) into
pooled-and-sliced securities for sale to investors. The theory of
securitization is that by cooking these assets together into a stew to
be served to many, the risk is deftly diversified into in a mix that
tastes better than its at-times bitter ingredients. Leading up to
the current financial state, just in case any doubt still existed about
securitized assets, as further buttress, these securities had their
credit quality enhanced by sweetening devices like bond
insurance. Adding insult to injury, securitized mixes were
declared particularly worthy by credit ratings agencies (CRAs) that
awarded credit ratings that now appear to have been unjustifiably
high.
If only it had all worked as planned. As it turns out, these
complicated securities often went down like a bitter pill –
leaving many investors holding worthless assets, backed by risky real
estate, corporate loans and meaningless investment-grade ratings.
Investors are taking action to avoid – or at least minimize
– the prospect of great losses. Facing off with financial
institutions that are dodging critics, disappearing, or both, investors
are taking several different approaches.
To understand the various approaches, the key players in issuing
securitized bonds must be understood. The securitizations that got us
into trouble rested on four major players:
- The credit rating agency (which, allegedly stood guard over the securitization edifice);
- The asset originator (mortgage lender, corporate lender etc.);
- Investment banks (which often acted in the dual roles of
the sponsor, that aggregated assets into the issuer and underwriter
that assisted the issuer in the offering); and
- Credit enhancement firms (often, a bond insurance company that sold enhancement to the issuer).
Litigations surrounding these issues are essentially de-constructing
the securitization players and looking to pursue different classes of
players. This tactic is quite helpful both in pursuing past
players and in targeting the structures and players that will be used
in a rejuvenated securitization market, one that government’s
TALF program (among others) is meant to catapult.
As we’ve noted in recent issues of Legal Currents, some injured
parties look to pursue underwriters and ratings agencies for their role
in the offering process. Illustrating this point are ongoing lawsuits
like
Mease v. Fuld, where Bank of America, Citigroup and Wells Fargo are being sued as underwriters, and
Kramer v. Federal National Mortgage Association,
where CRAs are being charged with having a role in making false and
misleading statements in offering documents. Some plaintiffs, however,
in order to obtain some sort of remedy, are going a step further and
pursuing those behind the securitization.
Another method of attack has been to pursue the asset originator, a
route that a motivated sponsor/underwriter might take...and there is no
more motivated bank than Lehman Brothers. This is seen in a complaint
filed by LBH against Millennium Mortgage Corp. in the U.S. District
Court for the Central District of California for selling bad mortgages
which should have never been sold in the first place. In its complaint,
LBH alleges that Millennium breached representations, warranties and
numerous other provisions of mortgage loan contracts and was therefore
required to repurchase the loans or provide monetary damages.
Yet another direction for some disgruntled plaintiffs is to go after
the bond insurer, which was exemplified this week in a lawsuit against
MBIA. On Wednesday, a class action suit was brought by hedge funds
including Aurelius Capital Partners LP and Fir Tree Partners, against
MBIA in the U.S. District Court of Manhattan, alleging that the
insurance company used fraudulent means in its restructuring by
transferring approximately $5.4 billion in assets from its parent
company, MBIA Insurance Corp., to a separate entity in order to protect
its officers, municipal bond holders and shareholders. In the
complaint, the plaintiffs, who owned securities guaranteed by MBIA,
describe the restructuring as “nothing short of a looting”
and seek to have the plan reversed by the court.
Taking a different tactic, the credit enhancement provider also seems
to be fair game. For an example, look no further than a recent
litigation brought by the Louisiana Stadium and Exposition District
(LSED) against the Financial Guaranty Insurance Company (FGIC), Merrill
Lynch and others in the Civil District Court for the Parish of Orleans.
LSED needed credit enhancement for nearly $239 million in auction rate
bonds and under the advice of Merrill Lynch, LSED entered into a $13
million agreement with FGIC to enhance the creditworthiness and
marketability of its bonds. In its complaint, the plaintiffs allege
that the defendants failed to disclose that FGIC had changed its
underwriting process, it had insured riskier obligation and that its
credit rating was in jeopardy and had it known these material facts, it
would not have entered into the insurance contract.
Even more companies have found themselves involved in similar
securitization litigations. J.P. Morgan Chase and MBIA, Inc. are
wrapped up in disputes analogous to Lehman’s battle with
Millennium, with the latter disclosing that back in September it had
filed suit against Countrywide for engaging in fraud in the origination
and sale of home equity loans, which were part of MBIA Corp. backed
securitization pool of home equity loans. MBIA further asserts that
Countrywide breached its obligation to repurchase ineligible loans.
LSED’s dispute with FGIC is not that unique either as comparable
complaints have been filed against other companies by municipalities.
Litigation of this genre includes those against Genworth Financial and
Morgan Stanley, with the latter disclosing that it has been sued for
its involvement with the securitization of subprime loans by the City
of Cleveland for creating “a public nuisance.”
The age of securitization and the culture of shirking individual
responsibility have left us with the current financial mess. The past
situation may have given us lemons, but some are now doing whatever
possible to make lemonade. In response to the recent troubles, the
government hopes to boost the credit markets by increasing investor
confidence in securitizations through the TALF program. The courts are
being asked to do their part to correct some of the wrong as
well. Going forward though, it may also be necessary for
regulatory bodies to require stricter disclosure requirements and
governments to pass laws which provide a more regulated framework to
deal with securitization to prevent a similar collapse of the financial
markets in the future.
Published: March 12, 2009
