ABK), Assured Guarantee ( AGO) and MBIA ( MBI) anticipate recovering more than twice as much as they did in 2008, when the financial crisis triggered insurance payments to units of the largest commercial and investment banks, which received bailouts from the government. Insurers recovered $4.2 billion in 2008. Ambac is pushing to get $2.6 billion, $1.9 billion of which stems from residential mortgage-backed securities, or RMBS, according to filings. Assured Guarantee reported $994.5 million, and MBIA $3 billion, including $1.9 billion related to RMBS, the companies said in recently released 2009 financial statements. As the credit crunch shook the financial system in mid-2008, bond insurers Ambac and MBIA paid billions of dollars to banks that had bought policies. Soon after, they suffered downgrades by credit-rating agencies, worsening the pain. Bond insurers typically operate on a pay-on-demand basis, leading to disputes over eligibility of payouts lasting long after the payments have been made. The mortgage crisis and downgrades kept Ambac and MBIA from selling policies, leading them to the brink of bankruptcy. Ambac is still struggling to ensure it has sufficient money to operate, though it has enough to satisfy insurance regulators. MBIA is in a slightly better position. Cash from the banks would provide a victory and a much-needed lifeline for the insurers. The bond insurers have alleged that underwriting policies were deliberately ignored or changed. In addition, they say existing delinquent accounts or those whose collateral value was overstated are common. The banks disagree, saying insurers knew the situation. However, motions to dismiss the suits have been met with little success. Bond insurers say they have strong cases against the banks. For now, they're focusing on well-capitalized big banks to recover cash. The insurers have completed reviews of the underlying loans and collateral they had insured, concluding that many of the transactions never met agreed-upon standards. Still, bond insurers' auditors, as with MBIA, caution that "the uncertainty inherent in the estimation of the financial effects of this matter is substantial." In other words, the insurers may get a lot less than they're hoping for.
The insurers now are demanding that banks recompense them. The banks are playing hardball, resisting the negotiating process and, in several cases, forcing the insurers to file lawsuits. MBIA believes it can make recoveries because of the strength of its existing contract claims and the improving financial strength of RMBS issuers. In addition, Freddie Mac ( FRE) has recieved "substantial'' amounts in similar claims, and the New York Supreme Court has denied motions to dismiss claims in at least two cases. Moreover, MBIA claims that repurchase reserves have been established by RMBS sellers and servicers to cover future obligations. A delay in settlements favors the banks because they can continue to generate reserves and strengthen their balance sheets, retain cash flow and, all the while, aim for negotiated settlements. Bond insurers, hungry for cash, might be prepared to settle for less to guarantee their survival. Waiting for their day in court could take three years, according to Ambac. Banks have little incentive to settle early. Also, because banks are, in some cases, stock holders of bond insurers, they would benefit from a rise in stock prices if insurers won lawsuits. Citigroup owns millions of Ambac shares, while JPMorgan holds $19 million in Assured Guaranty stock. Credit Suisse ( CS) holds $1.5 million in MBIA. Those are small amounts relative to the suits, but a substantial dollar value. Ambac and MBIA, while continuing to review portfolios, have vowed to recover what they deem is theirs if additional irregularities are found and settlements can't be reached. Banks and insurers probably will settle many of the claims. Unfortunately for the insurers, time is on the banks' side. That means the bond insurers will need to generate positive cash flows even as the residential mortgage-backed securities market is under strain. That may be an insurmountable problem. -- Reported by Gavin Magor in Jupiter, Fla.