Monday, December 10, 2007

MBIA: I wonder who they found to pull that off

What did we learn today? As you probably know by now, Warburg Pincus has agreed to invest $500 million in MBIA stock (about 13% of the company), as well as backstop a $500 million shareholder rights offering which MBIA plans for 1Q 2008. In exchange for backing the future offering, Warburg is getting $500 million in warrants priced at $40/share. I'd think that if Warburg is willing to invest at $31/share, there won't be trouble getting the public to take another $500 million.

Perhaps more importantly, UBS is getting a $10 billion infusion, mostly from the government of Singapore and an unidentified Middle Eastern investor.

So what does that tell us? Mainly that there is capital still out there, and at the right price, some one think banks and/or monolines are a worthy investment. But we kind of knew that already, this really just confirms it. We've seen Countrywide, Citigroup, E*Trade, and CIFG recently get large cash infusions. So there is capital out there, willing to buy into subprime-tainted companies at the right price.

What else did we learn? Both MBIA and UBS announced they expected to take large losses. MBIA said they would set aside up to $800 million to cover losses, and that the "fair value" of their portfolio has declined by $850 billion in the 4th quarter. UBS said they were taking a $10 billion write down and warned that they may record a loss for all of 2007. Note that in both cases the losses being recorded are about equal to the equity infusion. So we've learned that both companies are merely replacing capital they've lost.

Now some commentators are already dismissing MBIA's new capital for this very reason. Beware the simplistic analyst! We knew MBIA had losses to take, that's exactly why they needed more capital. So you can't say the capital infusion is inadequate for the sole reason that MBIA announced losses. In fact, if I'm MBIA, today is the perfect day to increase my loss reserve, since the market will be focused on all the good news anyway.

However, my view is that this won't be the end of MBIA's need for more capital. MBIA has about $84 billion in residential ABS and "multi-sector" CDOs, vs. about $82 billion with AMBAC. I recently estimated that AMBAC would need $2-3 billion in new capital, so I'd suspect that before this is all said and done, MBIA comes back to the market for more. Note I didn't say that MBIA would get downgraded. I have a strong suspicion that the bond insurers have been tipped off by Moody's and Fitch as to how the capital adequacy studies are going. I further suspect that any capital improvements you hear about in the coming days are over and above what Moody's and Fitch will announce (supposedly next week) is needed.

The best case scenario for the bond insurers is that they get new capital now, and are able keep adding capital through run-off, writing new municipal policies, smaller hybrid/preferred offerings, etc. As long as these increases in capital keep up with any losses they take, the ratings agencies never threaten a downgrade again. More importantly, the investing public still values bond insurance as a concept, since we'll all view the current episode as proving the insurer's strength rather than a failure of risk management. I view this as unlikely.

The worst case scenario is that all or most of them raise new capital now (which is inevitable), but investors downgrade the value of bond insurance generally. Its possible this causes the bond insurers' book to dwindle to nothing, but I doubt it. More likely is that bond insurance changes from being written to "zero loss" as it is now, to being written mostly on riskier municipal credits. In other words, MBIA's business model changes to being closer to Radian's model is currently. MBIA charges more for its insurance, but write a lot fewer policies. Whether all the current players in bond insurance can survive in such a world is yet to be seen.

Disclosure: No position in any company mentioned, although I own many insured municipal bonds.


Anonymous said...


Your blog is one of the best I ran accross. Keep up the good work.

Just curious, in your deep dive into ABK, you stated that they might have loses in excess of their cap requirement. The excess is in the neighborhood of 1.5 Bil. This was before the rescue plan by the government which you noted was very good for the monolines. This should reduce the losts for ABK. Instead of 1.5 Bil, now they might only need 1 bil or 500 Mil, say.

Yet, you seem to now say that situation is getting worse. What changed your mind?


Accrued Interest said...

I think the Hope Now helps improve their losses on direct subprime, which I estimated to be about $2 billion in losses. I also figured about $4 billion in losses in CDOs, which I don't think is helped at all by Hope Now. So they still have like $4 billion in losses over and above the $1-$2 billion in excess capital they currently have, even if you push subprime losses to zero.

But like I said, I would bet that the ratings agencies affirm the AAA. For now.

Anonymous said...

Highly simple, not to say stupid, question:

I hold municipal bond X.

What are the chances of X defaulting?

What are the chances that I will be made whole by X's insuror?

I thought the deal with municipals was that they could tax their municipalities to pay the bond and the interest. In fact, I thought that, in many cases, the "insurance" for the bond was the municipality's tax power.

What did I miss?

And I apologize in advance for being completely dumb.

Accrued Interest said...

Not dumb at all.

Municipal bonds VERY RARELY default. Municipal bonds that serve an essential governmental purpose almost never default. At least not historically.

So if your municipal is a State of Idaho General Obligation insured by MBIA, odds of you suffering a default are very low indeed.

If its Grassy Knoll Nursing Home, that's entirely different. What is it that you own? If you want you can e-mail me: accruedint AT

wagner2626 said...

I wonder how much the Hope Now plan will help the mortgage insurers. Of the exposure that MBIA has disclosed it seems that only a small portion of their residential exposure is direct subprime.

Much more is prime, although I believe that MBIA defimnes prime as FICO>620 and the plan defines it as FICO>660 so there is some over lap. The plan does not directly help prime borrowers, even if keeping other people in their homes so that the properties are not sold at foreclosure prices is a great indirect effect. But the fact remains that much of the insured MBIA RMBS portfolio will not be directly helped by the plan.

Applying the losses that the mortgage insurers have had to the 2nd lien/HELOC portfolio of of MBIA suggest a loss of about $1bn. So the capital that WP just infused would be taken up without applying any to the subprime exposure.

This capital raise will not doubt help, but I suspect that there is at least one more coming.

Furthermore the business is shrinking. Listen to the mini-conference that BoA held on the monolines and they say that over the last quarter only 40% of muni have been wrapped as opposed to 50% previously. That's a 20% decline in the number of contracts written. OK they are able to charge more, but the increase in the price is peanuts compared to the rise in the cost of capital of the monolines themselves.

In short, these companies will need additional capital to make it to the point where they can be smaller companies. I wonder what sort of mind trick was done on Warburg to get them to invest here.

RowdyRoddyPiper said...

Nit: You have $850bn loss in fair value in para 4. I believe you mean $850MM.

Substantively: Extrapolating from AMBAC to MBIA is not a great analysis. For example in the 06-07 vintage Mezz SF CDO space (generally the area considered most susceptible to loss) AMBAC had 6X the exposure of MBIA. CIFG 10X the exposure of MBIA.

I think the moves made by MBIA are prudent but hardly necessary to ensure their long term survival. At the end of the day as long as the regulatory capital arb is there for wrapped tranches the market will find a way to get wrapped deals done.

Sivaram Velauthapillai said...

Wagner2626: "Furthermore the business is shrinking...OK they are able to charge more, but the increase in the price is peanuts compared to the rise in the cost of capital of the monolines themselves."

I'm not so sure you can make the argument that the business will shrink based on what is happening right now. Certainly some customers are probably forgoing insurance right now but we don't know if that is permanent.

I'm sure most of the bond insurers, including the ones that don't have heavy RMBS or CDO exposure, are purposely holding back from writing any insurance (at least on anything housing related). We really don't know how much of the decline in bond insurance underwriting is due to purposely holding back versus customers losing a permanent interest.

Furthermore, I am not so sure I agree with your view that the price increase will be peanuts. Although the stock price performance may not have indicate it in the last few years, the bond insurance business was actually pretty bad in the last few years. It was very competitive and the spreads on lower quality bonds have been very low. Right now the spreads on lower quality debt are increasing and my opinion is that they will keep increasing. This is actually a more profitable environment for bond insurers. If I were a shareholder, I would pick less underwriting at higher spreads than more underwriting in tighter spread environment.

Having said all that, I think future growth from structured products (like CDOs) will be weaker in the future. Companies that depended on that for growth in the past (eg. Ambac) will likely see weaker profit growth than in the near-past. I'm considering investing in Ambac but that is almost solely based on valuation than future growth.

Richie said...

Question...with spread the way they are and a lot of banks strapped for capital, does that mean good lending prospects for banks with good capital ratios (i.e. JP Morgan)? Seems to me that they have plenty of cash on hand and can make solid loans at some killer prices. Although they have to be careful who to lend to, there are plenty of legitimate borrowers out there who are going to need loans.

Anonymous said...

"willing to invest at the right price" - that's an interesting formulation. how about "willing to invest at a discount to where things used to trade, thus apparently at a bargain basement level."

I'll never forget a guy on CNBC touting is patience and investment prowess when he bought CSCO at $50 - that's down from 80, so he claimed that there was a lot of people still willing to buy quality businesses at the "right price."

Lets see where it's trading a year from now or two - then we'll know if this was "the right price" or not.

EJ said...

Suppose MBIA and AMBAC are downgraded to AA instead of AAA.
Would they still have some sort of viable business left and over time hope to get upgraded again?

EJ said...

A lot of the assets of MBIA and AMBAC are municipal bonds, insured by MBIA and AMBAC themselves. Kind of incestuous.

If they get downgraded, those bonds would get downgraded, decline in value, and undermine their ability to pay insurance claims.

Question is: how much would those bonds decline in value if they are downgraded?

Accrued Interest said...

As to the "right price" comment, you are right. What I meant by "right price" is in the eyes of the buyer. Nothing more.

EJ: The capital constraints aren't based on the municipal's insured rating. Its based on its uninsured rating.

Whether or not they have a business without the AAA? I doubt it. There is room for non-AAA insurers (Radian) but not at the kind of size that AMBAC or MBIA currently operate.

Richie: I think the answer is yes.

Wagner2626 said...

Sivaram Velauthapillai: While prices have increased and this is beneficial to the monolines, the pricing increases in the muni world have not been that big. This is true because the spread differential between AAA and say A munis just is not that big. Why would a muni want to pay 30 bps per year to improve the yield tha they pay by 20 bps? Perhaps the market for insuring munis will return to the levels that it had late last year (50% of issuance), but certaintly the structured stuff will not see the same amount of interest at least for a long time.

Combine this with the dilution that they are facing from the capital raising. 16mm shares to WP + 16mm warrents + appox 16mm in the rights offering. vs 125mm pre capital raise shares - that's a 40% dilution. Let us say that the $73 share price that MBI hit earlier this year was right, simply with the dilution it should be worth $44. I will conceed for a moment that the amount of business will be offset by the increase in spread they can charge. That still leaves the uncertainty from what is on their balance sheet already - for arguement's sake let us say that this is worth 20% in the stock. That means that the stock is worth $35. Buying today at $33 is no real bargan.

There are lots and lots of financial stocks that have had big losses where the underlying business is not so challenged as here, where the questions about what is on the balance sheet are not so severe and where leverage is significantly lower. Look at SFI (iStar) for one.

Brian said...

I'd like to throw this out for comment as I'm trying to understand what this might mean for MBIA. It appears that MBIA (see the Bloomberg story attached below) has replaced the manager of the CDO (SAI is an affiliate of Wachovia) presumably taking direct control of the CDO. It appears that SAI, the manager not the fund, if this story is to be believed, had a credit line that was to be used to backstop the fund's obligations under CDS contracts, which credit line has been cancelled. It now looks like the CDO will have to sell assets to generate the liquidity required to fulfill its obligations under the CDS contracts.

This raises the following questions: Is MBIA in some way obligated to replace the line of credit that SAI had? How many other CDOs have similar structures such that an event of default blows up the backstop credit facility and effective accelerates the maturity (in part or in whole) of the CDO. One of the arguments for the bull case in MBIA has been that even if the guaranteed CDOs run into problems, that since they have long dated maturities, the present value of the obligations is not that large. If more of the CDOs they have insured have been structured in the same way as Sagittarius, that argument would appear to be invalid. I don't know the answer to the question, but would appreciate any informed comment.

MBIA's LaCrosse Unit Removes Wachovia's SAI From Managing CDO

By Neil Unmack

Dec. 12 (Bloomberg) -- LaCrosse Financial Products LLC, a unit of bond insurer MBIA Inc., removed Wachovia Corp.'s Structured Asset Investors LLC as manager of a $1 billion collateralized debt obligation.

SAI's management of the Sagittarius CDO I Ltd. was canceled under terms set out when the deal was structured, according to a Regulatory News Service statement. Cayman Islands-registered Sagittarius didn't provide details on the reasons for SAI's removal.

The CDO, set up in March, had its debt downgraded last week to as low as CC by Standard & Poor's, 10 levels below investment grade, after a funding line for SAI was withdrawn. Sagittarius, which pools mortgage and asset-backed bonds, had an ``event of default'' in November, S&P said.

Sagittarius may have to sell assets to meet payments on a credit-default swap because SAI can't draw its liquidity backstop, S&P said Dec. 6. Wachovia is the CDO's liquidity provider, according to the deal's prospectus.

MBIA, based in Armonk, New York, set up LaCrosse in 1999 to arrange derivatives used to guarantee CDOs, according to the bond insurer's Web site. The announcement didn't provide details on LaCrosse's role in Sagittarius.

MBIA spokeswoman Liz James in Armonk declined to comment and Wachovia spokeswoman Elise Wilkinson didn't immediately return calls for comment.

Position Canceled

Lacrosse canceled SAI's position as collateral manager under its so-called ``for cause'' conditions, according to the statement. Reasons for termination under the conditions include certain events of default, declines in the value of the assets backing the CDO beyond a certain point or a sale of the asset manager, according to the CDO's prospectus.

Charlotte, North Carolina-based Wachovia set up SAI in April 2004.

S&P cut the AAA credit ratings on Sagittarius' highest- ranking debt to BB, two levels below investment grade.

RowdyRoddyPiper said...


Saggitarius is a synthetic ABS trade. The backstop is likely to the deal not to the manager. It's meant to cover payments to protection buyers (the assets of the deal are credit default swaps referencing ABS). I'm assuming here for a minute as I haven't read the OM but MBIA is exercising their right as controlling class to kick out the manager based on a breach in the par value haircuts.

Basicallly when the reference assets take a downgrade the par value attributed to them takes a haircut based on the rating level they are downgraded to. After a certain amount of par value is lost via haircut, the controlling class (in this case MBIA) has the option to remove the manager. If there are not payments due under the default swap then there would be no need to liquidate. In any event the liquidity facility in these deals is not meant to absorb credit loss, just to smooth the timing of the payments due under the default swaps.

Without reading the OM I can't say with certainty but I can tell you in similar deals that I've structured MBIA does not have the obligation to replace the liquidity provider. They may have to try as collateral manager, but MBIA itself would not be on the hook to do so.

kernelbleeper said...

Ambac reinsures $29bn slice of portfolio to shore up capital base

By Stacy-Marie Ishmael in New York

Published: December 14 2007 02:00 | Last updated: December 14 2007 02:00

Ambac, the world's second largest bond insurer, yesterday said it had agreed to reinsure a $29bn slice of its portfolio as part of an attempt to improve its capital base.

The insurer will transfer the risk associated with 5 per cent of its portfolio to Assured Guaranty, allowing Ambac to release the capital backing the insured securities.

Ratings agencies have warned that Ambac and other bond insurers risk losing their triple A credit ratings unless they shore up existing capital reserves.

"Reinsurance is a valuable, capital efficient and shareholder friendly tool for managing risk and capital in the financial guaranty industry," said Robert Genader, chief executive officer.

The deal is part of the company's broader plan to raise capital, according to a company spokesman who declined to comment further.

The agreement with Assured has not yet been finalised and is contingent on the Bermuda-based company raising enough capital to support the policy.

Assured on Tuesday launched a $300m common equity offering, some of the proceeds of which will be used to support the deal. The reinsurer expects to complete the offering by the end of next week.

The $29bn commitment from Assured Guaranty would, when finalised, release at least $300m of existing capital, analysts said.

"It's not a big chunk, but it would free up a decent amount of capital - around $300 to $500m, depending on the mix," said JPMorgan analyst Andrew Wessel.

The reinsurance will not extend to any of Ambac's residential mortgage-backed securities or collateralised debt obligations, but will cover other structured and municipal debt, Ambac said.

As of September 30, Ambac had insured $8.8bn of securities backed by subprime mortgages and $29.2bn of collateralised debt obligations linked to subprime.

Moody's and Fitch said last month Ambac faced a "moderate" risk of breaching benchmark capital requirements for its rating.