Municipal bond insurers would still be thriving today if big banks hadn't defrauded the insurers.
That's what executives representing two big bond insurers told a state hearing Wednesday. They claim they were tricked by banks into wrapping toxic residential mortgage-backed securities. They said the banks now refuse to comply with contracts committing them to repurchase defective loans. Such arguments have been working through the judicial system since 2008. In recent months insurers have been seeking legislative and regulatory assistance to pressure banks into responding.
Losses suffered by insurers from mortgage-backed securities were big enough to collapse most of the companies involved in the business and reduce insurance penetration to less than 10% of the market. Potential winnings from ongoing litigation and out-of-court settlements could be enough to revitalize the industry, executives said before the New York State Assembly Committee on Insurance.
"It's very clear that problems surrounding the RMBS securities have decimated the financial guarantee insurance business," said Bruce Stern, executive officer of government and corporate affairs at Assured Guaranty Ltd. "We're hoping … to put more pressure on these people to do the right thing."
At Sept. 30, Assured had paid $2.8 billion in claims to RMBS investors. According to testimony, Assured has reviewed 36,000 loan files totaling $5.3 billion, identifying more than 31,000 with breaches of contract that could force banks to buy back loans.
Insurers say most of the products were defective from the start. MBIA Inc., once the most-active insurer and now an active plaintiff, had paid $4.2 billion in mortgage-backed claims at Sept. 30. Its CEO, Jay Brown, told the hearing that he expects MBIA to pay more than $1 billion in future claims.
When certain pools began defaulting at high rates in 2007, MBIA hired third-party firms to investigate loan files. The results were stunning. The firms found that more than 80% of the loans violated underwriting guidelines.
"Documentation violations were prolific," Brown said, adding that loans were regularly approved when a borrower's debt-to-income ratio exceeded guideline limits. "It was much harder to find loans that were actually eligible for inclusion in the pools than it was to find loans with multiple breaches."
Insurers say they couldn't know this at the time. Reviewing loans on a case-by-case basis before insuring the pool wasn't feasible, so they relied on data from the banks, who offered representations and warranties within the insurance contracts. The reps and warranties state clearly, insurers say, that if mortgage loans in the pools fail to meet stated criteria, originators would repurchase or cure the defective loan.
"The contract is clear," said Dominic Frederico, Assured's CEO. "The guarantor does agree to pay all claims when presented, but can compel the sponsor to repurchase loans that do not meet the agreed-upon standards."
Through Sept. 30, Assured had obtained $390 million in repurchase commitments, or "putbacks." That is expected to rise as more settlements are reached, more files are reviewed and as Assured incurs more losses.
The New York Bankers Association said reps and warranties were meant to supplement due diligence, not serve as a substitute. It submitted written testimony urging the committee to await the outcome of litigation before adopting new legislation. "It is important to note," the group said, "that underwriting guidelines are just that — guidelines."
