Bond insurer MBIA has admitted to making errors in its application to regulators seeking to split the company in two.

Chief Financial Officer Chuck Chaplin made the acknowledgement in an affidavit filed last week in a case before New York County’s supreme court in Manhattan.

Several banks are suing MBIA and Eric Dinallo, who formerly was superintendent of the New York Insurance Department, concerning the division of MBIA in 2009. The split created one firm that insures municipal bonds and another that insures structured finance products, including mortgage-backed securities that MBIA guaranteed before the financial crisis turned them into toxic assets.

MBIA and other companies insured these securities by selling credit default swaps to banks.
When the recession hit in 2008, real estate values plunged, unemployment spiked, and many homeowners stopped making payments on their mortgages. The securities turned out to be worth far less than promised.

After the securities failed, many banks asked MBIA to make good on its pledge to insure them.
Many banks responded to MBIA’s action to separate its muni book from the rest of its policies by suing MBIA and Dinallo, who approved the move.

For its part, MBIA has sued various banks for misrepresenting the soundness of the mortgage loans the banks had MBIA insure.

In a 12 page-sworn affidavit, Chaplin acknowledged that MBIA made errors in the record submitted to the Insurance Department in support of its Dec. 5, 2008, transformation application. In particular, MBIA made errors in the methods used to calculate how MBIA would fare in stressful economic situations.

Most of the errors relate to how MBIA would treat tax benefits from losses. Insurance losses lead to tax benefits. These benefits are supposed to be spread out over several years. However, in the submitted application, all the tax benefits were credited up front.

According to Chaplin, the net effect of all the errors was to overstate the anticipated financial health of MBIA in a hypothetical stressful condition, but understate its health after this condition had passed.

After Chaplin made his affidavit, Dinallo and Jack Buckmiller, the supervising risk management specialist in the capital markets bureau of the Insurance Department, submitted affidavits with the court. Dinallo and Buckmiller were central in approving the split of MBIA. In their affidavits, both men said that if the corrections been made to MBIA’s financial projections, it still would not have affected their decisions to allow the division of MBIA.

“The modeling errors referenced in Mr. Chaplin’s affidavit are primarily applicable only to the hypothetical extreme stress scenario provided to the Insurance Department in connection with its analysis and did not impact MBIA Corp.’s financial solvency or ability to meet its obligations to policyholders even in that hypothetical stress scenario,” MBIA spokesman Kevin Brown told ASR sister publication The Bond Buyer.

On another topic, Dinallo acknowledged in an affidavit that there was a “significant degree of uncertainty” in MBIA’s loss projections in its transformation application.

However, he indicated that he believed there would be this degree of uncertainty “in anyone’s predictions of future events or analysis of these predictions.”

Dinallo’s attorney did not immediately respond to a request for comment.

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