Lehman to Pay $2.4 Billion to End Crisis-Era Mortgage Claims

(Bloomberg) -- Lehman Brothers Holdings Inc.'s bankruptcy estate will pay $2.38 billion to compensate for its role in the previous decade's mortgage crisis, a federal judge decided, far less than the $11.4 billion some hedge funds had sought.

U.S. Bankruptcy Judge Shelley Chapman ruled in Manhattan Thursday after a 22-day trial to resolve the long-running dispute over Lehman's flawed residential mortgage-backed securities. Her decision puts a final tally on what buyers of the securities, known as RMBS, can recover for breaches by the investment bank when it pooled individual home loans and sold them off as bonds during the housing bubble.

A settlement of RMBS claims is a landmark for Lehman's other creditors because it frees up more of the defunct bank's assets to distribute. Lehman recently closed out a $2 billion dispute with Citigroup Inc. over derivatives, and similar litigation over derivatives with Credit Suisse Group AG is the last major remaining contest.

‘Burden of Proof'

Lehman "created and enjoyed a robust market" in securitizing home loans, Chapman said, recounting the company's role in the financial crisis. But plans went awry when the housing bubble popped and defaults soared on mortgage bonds, which “threatened to pull the entire U.S. economy into the abyss as well,” Chapman said. New York-based Lehman went bankrupt in 2008.

The trustees failed to meet a “burden of proof” to show breaches on around 72,000 loans, and struggled to categorize massive amounts of data by making some loans representative of others, she said. Chapman also said Lehman's administrator was unable to provide enough information, and that ultimately she turned to an earlier settlement by institutional investors who had valued claims at around $2.4 billion.

While Lehman's estate has said that holders of the RMBS should get $2.38 billion at most, and some institutional holders agreed to a similar number, a group of trustees initially sought $37 billion and argued at trial for $11.4 billion.

Chapman's ruling concerns hundreds of thousands of loans that Lehman packaged into RMBS from 2002 to 2007, telling investors that the documents for each loan contained no "untrue statement" and that borrowers hadn't given false or misleading information. A complex estimation trial that ran from November to February waded through thousands of loan records on which the trustees asserted breaches.

Grueling Process

Chapman called the process “grueling” but said it now adds to the growing body of precedents on resolving RMBS disputes. Other large banks have dealt with the issue outside of bankruptcy courts. Royal Bank of Scotland Group Plc this week agreed to pay $500 million to resolve a New York state probe on how it marketed RMBS.

Following Lehman's 2008 bankruptcy, trustees representing hedge funds and institutional investors brought a claim, saying Lehman breached its contract.

“Lehman's own documents show it was aware of the widespread problems and deteriorating performance of the loans it had securitized,” with half the loans at one point containing material misrepresentations, the trustees said in a court filing.

‘Blunderbuss Approach'

Lehman argued that the trustees took a "blunderbuss approach" in an attempt to squeeze money out of its defunct estate, citing an abrupt turnaround when they decided at one point not to pursue 40 percent of their initial breach claims.

“We are gratified with the court's well-reasoned and thorough ruling which we believe is a fair result for all creditors of the estate,” said Willkie Farr & Gallagher partner Todd Cosenza, who served as lead trial counsel for Lehman.

Around 14 large institutional holders, including Goldman Sachs Asset Management LP and BlackRock Financial Management, broke ranks with hedge funds and accepted a settlement last year valuing claims around $2.4 billion. Chapman noted that these "sophisticated players" held around 24 percent of the RMBS.

Potential Rift

But some hedge funds continued to fight hard for the $11.4 billion number, sending the process to trial.

The trustees representing RMBS holders are Deutsche Bank National Trust Co., Law Debenture Trust Co. of New York, U.S. Bank National Association and Wilmington Trust Co., according to court papers.

A group of hedge funds, including Whitebox Advisors LLC, Deer Park Road Management Co. and Tilden Park Capital Management LP, was formed in 2016, and expanded in May 2017 to include Prophet Capital Management LP, Tricadia Capital Management LLC, BlueMountain Capital Management LLC and others, according to court records.

The case is In re Lehman Brothers Holdings Inc., 08-13555, U.S. Bankruptcy Court, Southern District of New York (Manhattan.)

To contact the reporter on this story: Tiffany Kary in New York at tkary@bloomberg.net.

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, Rick Green

©2018 Bloomberg L.P.