The American Securitization Forum (ASF) has filed an amicus curiae, or friend of the court, brief in the case of MBIA Insurance Corporation and Wells Fargo Bank Minnesota, N.A. versus Royal Indemnity Company (Royal), in which Royal is appealing an adverse lower court decision.
The ASF’s brief focuses on the important role played by financial guaranty insurance in the securitization and broader bond markets, and the understandings and expectations of market participants regarding the interpretation and enforcement of financial guaranty insurance policies.
The case arises out of credit insurance policies covering securitized student loans, under which Royal was unconditionally obligated to make payments upon defaulted loans. However, upon default, Royal claimed that the originator fraudulently induced it to issue the policies by covering up prior default rates, and it refused to honor its payment obligation.
MBIA, which provided a separate financial guaranty on the securitized notes that was meant to guarantee Royal’s credit, won a summary judgment in the Federal District Court in Delaware which held Royal responsible for payment, a decision that Royal is now appealing. In its brief, the ASF urges the appellate court to reject Royal’s appeal.
“In challenging the validity of its Policies in this case, Royal attacks the conceptual underpinning of a major component of the securitization and structured credit markets–the explicit and contractually agreed-to allocation of risk among different parties to a transaction,” the ASF brief states. Noting that the insurance policies issued by Royal explicitly stated that they were “absolute,” “irrevocable” and “unconditional,” the ASF argues that “A decision reversing the District Court and allowing Royal to escape its absolute and unconditional obligations under the policies would increase market uncertainty regarding financial guaranty and similar insurance policies, permit sophisticated parties to avoid or delay their contractually-agreed performance to the detriment of innocent purchasers of securities, and adversely affect the efficiency and liquidity of the securitization and broader capital markets.”
The ASF, which represents institutional investors and a range of other securitization market participants, emphasized in its filing with the court the importance of preserving investor expectations regarding the role and function of credit enhancement provided in the form of financial guaranty insurance. The ASF is an adjunct forum of The Bond Market Association.
“It is understood in the capital markets that, when a credit enhancer like Royal provides credit enhancement of the underlying assets that are to be securitized (including student loans), it, and not the investor or the insurer of the investor’s securities, is responsible for the non-performance of the asset that is credit-enhanced; indeed, a principal reason for purchasing credit enhancement in structured transactions is to effectuate this allocation of due diligence responsibilities (and accompanying risks) away from investors and to the credit enhancer of the underlying assets,” its brief stated.