Moody's: Bond Insurers May Benefit from Assured/Flagstar MBS Court Decision

A court decision last week ordering Flagstar Bank to pay $90.1 million to bond insurer Assured Guaranty as compensation for losses incurred on insured mortgage-backed securities should benefit other financial guarantors by giving them leverage in their own lawsuits against banks for losses sustained during the financial crisis, according to Moody’s Investors Service.

“The Assured/Flagstar case is the first of the ‘mortgage-putback’ cases brought by financial guarantors against mortgage originators to go to trial,” say James Eck, vice president and senior credit officer of Moody’s and David Fanger, Moody’s senior vice president in the ratings agency’s latest Weekly Credit Outlook.

Companies such as Assured Guaranty and MBIA, among others, have argued that banks misrepresented the quality of loans that were packaged into mortgage-backed securities insured by bond insurers.    

Moody’s says, “The ruling in favor of Assured is credit positive for financial guarantors because it strengthens their negotiating positions in ongoing litigations against banks for alleged breaches of representations and warranties on mortgage loans within insured RMBS transactions.”

“For the financial guarantors, the stakes are high,” Moody’s continues. “As of third-quarter 2012, Assured had recorded $774 million of future mortgage loan putback recoveries...while MBIA Insurance Corporation...had recorded $3.2 billion. For capital-constrained guarantors such as MBIA, the ability to win trial verdicts and reach settlements with banks will have a meaningful effect on their policyholders and creditors.”

However, Moody’s notes that while the judge in this particular case, U.S. District Court Judge Jed Rakoff in Manhattan, found Assured experts “to be more convincing on balance than Flagstar’s, a different judge viewing different expert testimony could come to a different conclusion. As a result, it remains unclear whether this ruling will set precedent for upcoming trials.”

Moody’s does say it is significant that Judge Rakoff found that statistical sampling on a randomly selected group of loans is an appropriate method of proving liability in mortgage putback cases. “The use of statistical sampling makes it easier for the guarantors to prove their case because it relieves them of the burden of having to prove that a breach of representations and warranties occurred on each individual loan,” says the ratings agency.

Flagstar has announced it will appeal the decision.