The 11 banks contesting MBIA’s February 2009 restructuring have long said the regulatory process allowing the move was based on outdated and inaccurate financial information. Now, they have evidence.

Plaintiffs in the Article 78 proceeding against MBIA presented the New York State court on Tuesday with independent analysis showing that MBIA’s estimates of future losses on structured-finance guarantees may be short by more than $10 billion.

The restructuring allowed MBIA, a bond insurance holding company, to transfer $5 billion of capital from one platform, MBIA Insurance Corp., and create a new muni-only guarantor called National Public Finance Guarantee Corp.

Plaintiffs are 11 major banks including UBS and Bank of America. They claim the value of MBIA Insurance’s guarantee was irreparably harmed by the restructuring.

The analysis showing a $10 billion shortfall was conducted by BlackRock Solutions, an independent investment and risk management firm with more than $3.5 trillion of assets under management. BlackRock earlier provided valuations of the structured finance portfolios of bond insurers Ambac Assurance, CIFG, and Syncora Guarantee.

“The BlackRock loss projections put to rest any notion that MBIA Insurance likely will meet the enormous pending liabilities on its structured-finance insurance policies over the next 30 and more years,” said lawyers for Sullivan & Cromwell.

BlackRock’s base case for estimated future losses is $13.8 billion, versus MBIA Insurance Corp.’s actual loss reserves of $2.33 billion, before reinsurance, as of year-end 2010. The firm’s stress-case scenario estimates $20.8 billion of future losses.

BlackRock’s projections are based on 42 credit default swap positions, selected by plaintiffs, with a notional value of $28.5 billion as Dec. 31, 2008. It also evaluated 422 single-name residential mortgage-backed securities with an outstanding balance of $21.6 billion.

The New York Insurance Department (NYID) allegedly looked at only three such products in detail before approving MBIA’s proposal to shelter its municipal bond portfolio from its more toxic structured finance portfolio.

MBIA estimated in early 2009 that under an “extreme stress” scenario it would have to pay structured-finance claims of about $1.76 billion in 2009 and $1.24 billion in 2010, according to Sullivan & Cromwell. The reality: MBIA paid out roughly double those figures – $3.2 billion in 2009 and $2.6 billion in 2010.

Mark Paltrowitz, who heads BlackRock’s financial modeling group, said plaintiffs identified which securities to evaluate and directed BlackRock to use the MBIA discount rate, drawn from company 10-k filings,  to estimate claim values. Otherwise BlackRock operated independently and without input from plaintiffs.

Blackrock is partly owned by Barclays Capital and has close ties with Merrill Lynch, two of the original banks represented by plaintiffs in the case. Barclays, along with five other banks, has since removed itself from the case for undisclosed reasons.

BlackRock employed 20 people to evaluate the financial data, which court documents say is equivalent to 22% of MBIA’s structured-finance exposure as of year-end 2008. The NYID allegedly relied on just a single employee who evaluated MBIA’s financial condition over a five-week period.

Deploying the third-party analysis is meant to back up Sullivan & Cromwell’s criticism that the NYID failed to review detailed analysis of MBIA’s portfolio before the restructuring was approved.
According to email correspondence submitted to the court, NYID deputy superintendent Hampton Finer had recommended MBIA hire a third-party to perform analysis of expected losses in its structured finance portfolios. Finer said that would assist the department in making a “fair and equitable” determination.

MBIA did hire Bridge Associates to provide a “solvency opinion.” But plaintiffs called the analysis “virtually useless” because it allegedly relied entirely on MBIA’s own financial statements.

“MBIA Insurance’s failure to use the most up-to-date information to run those models – particularly in a time of such economic turmoil – created a classic case of 'garbage in, garbage out,’” said Ronald Greenspan, senior managing director at FTI Consulting, which was hired by plaintiffs to analyze the financial models MBIA submitted to the NYID.

Rene Stulz, a financial expert retained by plaintiffs to evaluate the loss reserves and projections calculated by MBIA, told the court the department’s approval process was “inadequate,” noting it “ignored clearly contradictory company and market evidence.”

“The third-party solvency opinion provided to the NYID by MBIA includes no true economic solvency analysis,” said Stulz, the chairman of banking and monetary economics at the Ohio State University.

“The loss estimates and stress tests inappropriately relied on stale data that did not sufficiently account for ¯ and sometimes blatantly ignored ¯ the rapid deterioration in the economy and in the financial markets during the critical months leading to the transformation,” he added.
MBIA has repeatedly denied these accusations and maintained that the NYID conducted a thorough analysis before approving the company restructuring.

In an emailed statement Tuesday, chief financial officer Chuck Chaplin reiterated “although MBIA and its counsel will respond to the materials filed by the banks in detail in due course, we believe that they are without merit and we remain confident that the court will affirm the New York State Insurance Department’s decision to approve MBIA’s Transformation, which came after a thorough and careful analysis.

“MBIA Insurance Corp. was solvent then and remains so today, two years and two unqualified audit opinions later.”

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