In 3Q09, MBIA continued to review the mortgage loans in its insured deals. Based on this, the expected net cash flows were revised based on these additional loan reviews.

The results were reflected in the estimated potential recoveries related to ineligible mortgage loans in certain insured first and second-lien MBS, which are subject to a contractual obligation by the sellers/servicers to repurchase or replace ineligible mortgage loans. This is according to yesterday's 10-Q filing with the Securities and Exchange Commission by the company.

According to the filing, the bond insurer’s recovery outlook is still mainly based on several  factors such as the strength of MBIA’s existing contract claims related to ineligible loan substitution/repurchase obligations.

The outlook is also based on  the favorable outcome for MBIA of its lawsuit versus Countrywide Home Loans where the court allowed MBIA’s fraud claims against the Countrywide defendants to proceed.

Additionally, it resulted from the improvement in the financial strength of issuers because of the mergers and acquisitions and/or government assistance, helping these issuers' ability to comply with their loan repurchase/substitution obligations. The insurer does not know of any provisions that explicitly preclude or limit the successors’ obligations to honor the obligations of the original sponsor. This is why MBIA did not make any considerable adjustments to its estimated recoveries related to the credit risk of these sponsors or their successors. There was also the evidence of loan repurchase/substitution compliance by issuers for put-back requests made by other harmed parties consistent with MBIA’s assertions.

Starting in 1Q08, MBIA has used loan level forensic review consultants to review a sample of the mortgage loan files underlying its insured deals backed by HELOC and closed-end second mortgages. Certain HELOC and CES transactions that experienced exceptionally poor performance were chosen for a re-underwriting review. The factors MBIA believes to be indicative of this poor performance include a material rise in early and late stage delinquencies; significant increases in charged-off loans; and considerable decreases in credit enhancement; and/or policy payments.

According to the filing, MBIA’s forensic loan review determined that there were significant breaches of mortgage loan representations as well as material deviations from underwriting guidelines.

MBIA has therefore determined that thousands of loans were contractually ineligible for inclusion in the securitized trusts insured by MBIA. In turn, it has submitted thousands of ineligible loans for repurchase/substitution to the sponsors or sellers/servicers.

The unsatisfactory resolution of these contractual matters,aside from the fraudulent underwriting practices that were prevalent within certain issuers, has led to MBIA pursuing litigation with these issuers seeking the sellers/servicers to repurchase or replace ineligible mortgage loans and specifically perform under its contractual obligation and damages for both breaches of contractual obligations and fraud. MBIA’s forensic examination of loan repurchase/substitution requirements for different issuers are still ongoing.

In 2Q09 and 3Q09, MBIA recognized estimated recoveries of $1.2 billion related to reviewed transactions. The estimated recoveries are transaction-specific and based upon contractual breaches for loans that were ineligible and either put back to the originators or sellers/servicers or where analysis has been completed and put-back notices are pending. These projected recoveries rely upon identified breaches of representations and warranties in specific transactions that MBIA has already identified as a result of actual loan file examinations for loans across a broad spectrum of categories ranging from current to severely delinquent and charged-off mortgage loans. In 2009, in coordination with forensic review consultants, 26,805 mortgage loans were reviewed within 27 first and second-lien MBS. The aggregate loan population includes current, delinquent and charged-off loans.

Estimated recoveries of $1.2 billion for these 27 deals is based on only those loans that were examined that had substantiated breaches, and does not include any extrapolation of results from the actual loan file examinations to the remaining mortgages in the loan pool. Expected cash inflows from recoveries for all transactions are discounted using the current risk-free rate associated with the underlying credit ranging from 2.02% to 3.38%, depending upon the transaction’s expected life.

The insurance firm considered all relevant facts and circumstances, such as factors detailed above, to develop its assumptions on expected cash inflows, probability of potential recoveries and the recovery periods.

The estimated amount and likelihood of potential recoveries are expected to be revised and supplemented as facts and circumstances change and relevant information is made available, including more data regarding the mortgage loan pools.

The bond insurer has used the results of the above described loan file examinations to make demands for loan repurchases from originators and services or their successors and, in certain instances, as a part of the basis for litigation filings.

MBIA will continue to assess the level of expected recoveries as it finishes more forensic reviews on additional loans and progresses through the litigation proceedings. Based on both factors, the bond firm's estimate of recoveries could change materially, the 10-Q filing indicated.

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