The New York Supreme Court on Wednesday ruled that MBIA Insurance Corp. did not have any way to discover if GMAC Mortgage LLC intentionally misrepresented the true nature of mortgage-backed securities that MBIA insured.
"It is not clear whether MBIA could have discovered the alleged misrepresentations concerning the loan characteristics before entering into the insurance agreements," Judge Bernard Fried wrote in his 15-page decision.
MBIA is a structured-finance bond insurer owned by MBIA Inc., a holding company that also runs muni-bond insurer National Public Finance Guarantee Corp. The companies have been unable to write new policies since 2008 because asset-backed bonds it insured wrecked its balance sheet, causing rating downgrades.
The case against GMAC is one of 11 cases in which MBIA alleges various financial institutions induced it to wrap asset-backed securities that didn't live up to stated underwriting standards. It seeks compensation for breaches of warranty and representations.
MBIA filed a complaint in April alleging that GMAC, one of the largest mortgage lenders in the country, "affirmatively misrepresented the quality of tens of thousands of mortgage loans" with a principal balance of $4.4 billion.
Those loans were then packaged into residential mortgage-backed securities and insured by MBIA.
GMAC, in its motion to dismiss in June, called MBIA's complaint "dubious," noting the guarantor is claiming to have been defrauded in an attempt to avoid losses from risks it voluntarily chose to insure.
"Sophisticated entities have an affirmative duty to conduct due diligence before entering into a transaction," lawyers for GMAC wrote in June, noting that MBIA admits it did not conduct due diligence on the transactions.
But Fried said that even if MBIA had conducted an investigation into the loan files, the transaction allowed GMAC to populate the mortgage pools with additional loans for three months after the closing date — in other words, probing the loans could be futile, as GMAC could potentially add faulty loans to the mortgage pool after the investigation.
"Accordingly, the fraud cause of action survives, and GMAC's request to dismiss the fraud claim is denied," Fried ruled.
The judge did, however, reject MBIA's claim that the two parties had a "special relationship" that allowed MBIA to place its trust and confidence in GMAC's representations. He also granted GMAC's motion to dismiss MBIA's claim alleging violation on grounds of good faith and fair dealing, calling the insurer's claims duplicative.
In April, Fried dismissed five of the six complaints MBIA made against Merrill Lynch regarding credit default swaps on certain bonds. He allowed a breach-of-contract claim to be pursued, but dismissed the idea that Merrill concocted a scheme to offload its deteriorating subprime mortgage portfolio to MBIA as "a classic case of buyer's remorse."
Earlier this month, MBIA Inc. sued Morgan Stanley, claiming the bank defrauded it into insuring $223 million of mortgage-backed securities that went bust during the financial crisis.
MBIA anticipates recovering at least $2.2 billion from the 11 cases, according to its third-quarter earnings statement.
Dominic Frederico, chief executive at Assured Guaranty Ltd., the active bond insurer that is also pursuing loan originators, recently said the story of mortgage recoveries is only in its early chapters.
"I think we're at the tip of the iceberg," he said.