Credit Suisse Group AG (CSGN) must face claims for certain damages in Assured Guaranty Ltd. (AGO)’s lawsuit over the quality of loans in pooled mortgages it insured, a New York appeals court said in a ruling that increases the bank’s risk in the litigation.
Assured Guaranty sued Credit Suisse’s DLJ Mortgage Capital Inc. unit in New York State Supreme Court in Manhattan in 2011, accusing the company of misrepresenting the quality of loans in six mortgage-backed securities transactions it guaranteed.
Justice Shirley Werner Kornreich in 2012 dismissed Assured Guaranty’s demand for a type of damages that would allow for a larger recovery. The judge said the insurer’s remedies for a breach of the pooling and servicing agreements governing the trusts that issued the securities do not include such damages.
A five-judge appellate panel in Manhattan today reinstated the claims, saying Assured Guaranty can recover rescissory and consequential damages because it didn’t sign the pooling and servicing agreements. As a result, Assured Guaranty may be able to collect more from Credit Suisse if it prevails at trial.
The agreements were “the result of negotiations between sophisticated business entities,” the court said. Omitting Assured Guaranty as a party “can only be construed” as intentionally excluding it from the agreements’ terms, the court said.
Pools of home loans securitized into bonds were a central part of the housing bubble that helped send the U.S. into the biggest recession since the 1930s. The housing market collapsed, and the crisis swept up lenders and investment banks as the market for the securities evaporated. Lawsuits between bond insurers and banks ensued.
Credit Suisse is facing similar claims in New York from bond insurer MBIA Inc. (MBI), which accused the Zurich-based bank in 2009 of making fraudulent misrepresentations in a $1 billion bond deal. The bank is defending lawsuits by the states of New York and New Jersey as well.
Claims for consequential damages seek to recover for the harm growing out of a contractual breach. Manal Mehta, founder of San Francisco-based Sunesis Capital LLC, which invests in bond insurers, said today’s decision allowing for such damages poses a “far more potent” threat to banks like Credit Suisse.
MBIA and Assured Guaranty “can afford a long battle,” he said in an e-mail. They “have the luxury of pushing for a knockout punch and extracting as much value as possible from the suits against Credit Suisse.”
Drew Benson, a spokesman for Credit Suisse, declined to comment on today’s ruling. Philippe Selendy, an attorney with Quinn Emanuel Urquhart & Sullivan LLP representing Hamilton, Bermuda-based Assured Guaranty, didn’t immediately respond to messages.
In its complaint, Assured Guaranty said Credit Suisse induced it to insure the transactions by making “pervasively and materially false” representations about the credit quality of the loans, the ratings of securities backed by the loans and due diligence.
Assured said it identified more than 8,800 defective loans, with total original principal of about $2.2 billion, out of 18,000 loans in the six transactions.
In her 2012 decision, Kornreich said Assured Guaranty could seek only to repurchase a loan, substitute another or otherwise cure the breach.
Credit Suisse on Feb. 6 posted fourth-quarter profit that missed analysts’ estimates after setting aside 514 million francs ($578.5 million) for U.S. tax and mortgage litigation.
Mark Palmer, an analyst with BTIG LLC in New York, said in a Feb. 10 note to investors that the reserves may be a sign that Credit Suisse is preparing to settle the MBIA and Assured Guaranty suits.
Credit Suisse hadn’t previously made provisions for potential losses associated with mortgage-backed securities and had refused to hold talks with MBIA and Assured Guaranty, Palmer said in the note. The bank settled a similar suit by Ambac Financial Group’s bond insurance unit in March.
Management of MBIA and Assured Guaranty “have expressed bewilderment at the fact that CS had for years not even made provision for potential losses” associated with mortgage-backed securities, he said, referring to Credit Suisse.
Mehta said he was surprised there was no settlement.
“Discovery will drag Credit Suisse through the courts and attract more scrutiny to the dark underbelly of mortgage securitization at DLJ,” he wrote. “It’s suicidal for them to continue this strategy of attrition.”
The case is Assured Guaranty Municipal Corp. v. DLJ Mortgage Capital Inc., 652837-2011, New York State Supreme Court (Manhattan).
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