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Credit Suisse Put ‘Garbage’ Mortgages in Bonds, MBIA Says

Credit Suisse Group AG (CS) bundled hundreds of mortgages into a single set of securities sold to investors in 2007 even after it had found flaws with the loans and asked the lenders to repurchase the debt, bond insurer MBIA Inc. (MBI) said in a court filing.

That practice was one way Zurich-based Credit Suisse maximized profit as the U.S. mortgage market melted down, while exposing investors and guarantors to losses, MBIA said in an amended complaint filed Jan. 30 in New York State Supreme Court as part of its 2009 suit against the bank. The filing cites documents obtained through the pretrial exchange of evidence.

The amended complaint said bank executives used the word “shady” and a vulgarity to describe mortgage companies it bought loans from. Some of them would “try to get away with anything” they could, including selling “utter complete garbage,” the executives said, according to MBIA. A Credit Suisse spokesman accused MBIA of mischaracterizing the evidence.

Six years after U.S. home prices began a slump of more than 30 percent, and a year into the recovery, mortgage-bond investors and insurers are still battling in court with banks over the hundreds of billions of dollars in resulting losses. Plaintiffs are pointing to pretrial evidence to bolster cases or bring new ones, saying the documents show the extent of Wall Street’s wrongdoing.

Photographer: Martin Oeser/dapd/AP Photo

Credit Suisse in Frankfurt, Germany. Close

Credit Suisse in Frankfurt, Germany.

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Photographer: Martin Oeser/dapd/AP Photo

Credit Suisse in Frankfurt, Germany.

‘Discredited Testimony’

“MBIA’s amended complaint is built on discredited testimony and fragments from a handful of e-mails that emerged after a review of millions of messages -- they are intentionally taken out of context,” Drew Benson, a spokesman for Credit Suisse, said. “We are confident the court will see this as a futile attempt to shore up a weak claim.”

Credit Suisse had sought to prevent the filing of Armonk, New York-based MBIA’s amended complaint in the suit over the $1 billion bond deal, saying in court documents that the description of an originator in an e-mail as “shady” occurred during a discussion of a loan product that the bank didn’t accept.

The Swiss bank agreed in November to pay $120 million to settle U.S. Securities and Exchange Commission allegations that it failed to tell investors it kept reimbursements from lenders for soured loans “previously” placed in bonds. The bank didn’t admit or deny the findings in the SEC case.

MBIA said it found the bank also bundled more than 500 mortgages into a 2007 deal even after demanding that lenders repurchase the debt because of early defaults or underwriting errors.

‘Red Flags’

Credit Suisse, one of two issuers to re-enter the market since it froze in 2008, said in a 2011 filing in the MBIA case that the transaction’s contracts failed to call for the bank to repurchase loans simply because they went delinquent within a few months or involved borrower fraud, differing from contracts between the lenders and Credit Suisse. MBIA said the bank knew early loan defaults were “red flags” for further reviews.

New York Attorney General Eric Schneiderman last year sued Credit Suisse, saying its 2006 and 2007 mortgage bonds suffered $11.2 billion of losses and there needed to be “real accountability for the illegal and deceptive conduct.”

“You talk about people selling tens of billions of dollars of securities over a period of years in which their due diligence process was essentially a sham,” Schneiderman said in an interview today. “That’s a big liability.”

‘Baseless’ Claim

Credit Suisse has called the state’s claims “baseless.” The bank is also contending with lawsuits from bond insurers Ambac Assurance Corp. and Assured Guaranty Corp. and investors including IKB Deutsche Industriebank AG and Stichting Pensioenfonds ABP.

Lenders, bond issuers and underwriters have said that plaintiffs are improperly blaming them for a collapse in housing or their own lack of care during the real estate boom.

“Damaging e-mails and other documents uncovered by lawsuits such as this will only intensify the public’s disdain for a system that is viewed as being riddled with fraud and self-dealing,” Manal Mehta, the founder of San Francisco-based hedge fund Sunesis Capital LLC, said in an interview. Sunesis owns MBIA shares.

MBIA has paid more than $386 million in claims on the 2007 Credit Suisse transaction, according to its amended complaint. A total of $597 million, or about 66 percent of the original balances of the second-lien loans underlying the deal, have defaulted and been charged-off, it said.

‘Double-Dipping’

The inclusion of loans that Credit Suisse had already sought to have repurchased fits with a broader scheme of “double-dipping” by both using and ignoring contract clauses requiring loan buybacks, MBIA said. Of the $205 million recovered from originators through December 2007, Credit Suisse kept $116 million as of that month, the insurer said it found.

Rather than formal repurchases, Credit Suisse sometimes also negotiated discounts on future loan sales, according to MBIA’s filing.

A senior trader described one executive as the “king of quietly forgiving” upfront payment demands in exchange for “incentive laden” agreements for future business, MBIA said in the amended complaint, citing the bank’s internal communications.

The trader said such practices “encourage these guys to continue delivering us cr-p,” according to MBIA’s filing.

New Century

Of the loans with repurchase demands included in the MBIA- insured deal, at least 182 had been submitted to failed subprime lender New Century Financial Corp. for buybacks, MBIA said, citing Credit Suisse records.

Credit Suisse’s records also show that it failed to conduct the 100 percent due diligence on New Century loans that it promised, even though the lender had filed for bankruptcy, which the bank acknowledged in disclosures increased the danger the debt would have flaws, according to the MBIA complaint.

Even while Credit Suisse maintained a “watch list” of problem loan sellers, it never stopped including their loans in securitizations, MBIA said. More than 2,600 of the loans securitized in the transaction MBIA insured, or 15 percent, were from originators on the watch list, according to the amended complaint.

As one Credit Suisse executive in March 2007 was suggesting the bank “cut them off or halt funding” for four lenders that originated about 750 loans in the deal, a trading head described the loans of one of them as “utter complete garbage,” MBIA said in its amended complaint, citing internal bank communications.

The case is MBIA Insurance Corp. v. Credit Suisse Securities (USA) LLC, 603751/2009, New York State Supreme Court (Manhattan).

To contact the reporters on this story: Jody Shenn in New York at jshenn@bloomberg.net; David McLaughlin in New York at dmclaughlin9@bloomberg.net

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; John Pickering at jpickering@bloomberg.net

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