I should never underestimate the relentless optimism of US equity investors (or perhaps the cleverness of MBIA’s flacks picking the middle of the night to release a fourth quarter earnings announcement that fell considerably short of already-low expectations).
Thursday we had the remarkable spectacle of MBIA CEO Gary Dunton making statements that can only be characterized as existing at the outer edge of credulity. As Bloomberg reported:
MBIA Inc. Chief Executive Officer Gary Dunton said the world’s largest bond insurer has more than enough capital to keep its AAA credit rating and dismissed speculation the company may go bankrupt.
This is breathtaking, and I am staggered that his attorneys would let him represent anything of the kind. Standard & Poor’s and Moody’s have said in no uncertain terms that both of the big bond insurers, MBIA and Ambac, need to raise more capital, pronto. Duncan’s statement, as far as his standing with the rating agencies is concerned, is patently untrue. And as we discuss later, S&P felt compelled to say as much in short order.
Similarly, New York state attorney general Eric Dinallo has been trying to get a $15 billion industry-wide rescue effort off the ground. The rating agencies were in the early meetings. If they though this initiative was unnecessary, they certainly would have spoken up.
Admittedly, Dunton has to put forward as brave a face as possible. He somehow, against all odds, managed to extract $500 million from a supposedly sophisticated private equity firm, Warburg Pincus. The last thing he can do on the heels of closing the deal is intimate that he sold Warburg Picus a bill of goods.
It is remotely possible that the company is badly deluded (and the deluded are usually more convincing than con artists, which may explain the successful placement with Warburg Pincus). A page one Wall Street Journal story, which gives a blow-by-blow recount of MBIA’s declining fortunes, has this revealing section:
The next day, Mr. Dorer [of Moody’s]and his colleague, Stanislas Rouyer, published new concerns about MBIA’s capital position, saying it was worse than previously thought. MBIA shares slid 16% on the news. On Dec. 10, MBIA announced it had raised $1 billion from Warburg Pincus, which it viewed as a victory because some of its peers were also seeking such financing.
Nevertheless, on Dec. 14, Moody’s put MBIA on “negative outlook,” the first step in considering a downgrade, jolting executives in Armonk who thought they had bought some time with the Warburg deal.
Mr. Dorer and his Moody’s team were changing their minds about MBIA’s situation, their published reports indicate. The company, they concluded, had slipped from one of the better positioned insurers to the middle of the problem, in large part because of its holdings of risky CDOs that held subprime mortgages.
Mr. Dorer says MBIA had increased its portfolio for much of 2007, just in time for the mortgage downturn. As far back as the summer, he says, “it became apparent that these were exposures that could have some significant volatility.”
By the end of the year, Mr. Dorer and his team were delivering bad news to MBIA in near-daily calls. In mid-January, Moody’s put MBIA on “review” for a downgrade, the next step in considering such a move. In a downbeat note, Moody’s predicted the business of bond insurers could be damaged for years.
These are “unprecedented market conditions,” says Mr. Dorer, who started following MBIA and other bond insurers in 1998.
Moody’s decision “caught us a bit by surprise,” says MBIA’s chief financial officer, Mr. Chaplin. He adds that he expects the company’s credit outlook to return to “stable” in the future.
There is absolutely no appreciation of how perilous their position is or, more important, how their business model is no longer viable. Return to stable? When they are losing new business to fears over their ratings stability and will have the best risks picked off by Berkshire Hathaway, which has an undisputed AAA?
But what is even more surprising is that the markets bought this garbage barge and staged a late afternoon rally. Even though Felix Salmon scores this as a win for MBIA and a sign that investors are tuning out, I see this differently.
First, Ackman (not that this is Ackman versus MBIA; in fact that is part of MBIA’s strategem, to personalize this as evil short seller versus misunderstood maligned company) and the other monoline skeptics are winning the war in the court of market opinon despite a wee setback. Even after Thursday’s perk up, the stock is way down, and credit default swaps are being priced as if bankruptcy is imminent. And the short interest is so massive that any upward move would lead to some protective buying.
Second, regardless of what Dunton says, conditions are deteriorating, his new business is falling off, and analysts ex Ackman are far more often than not coming out with even worse loss estimates. Ackman (and by implication, the unnamed Global Bank that supplied him with its model) are up to $23.2 billion in losses for MBIA and Ambac. Egan Jones puts industry losses at $80 billion, Oppenheimer at $70 billion, JP Morgan at $41 billion.
Third, the January 30 letter presents a financial model and more important, the full security-by-security list of ABS CDOs and RMBS guaranteed by the two big monolines in from 2005 to 2007. This is disclosure that MBIA and Ambac have been unwilling to make; it will enable the rating agencies and regulators to analyze the bond insurers’ exposures with more precisions, and also enable them to ask tougher questions.
One element that has been a bit misunderstood is the time frame of exposures. Optimists have asserted that the bond insurers will pay out their claims over many years, therefore the payment is considerably mitigated.
RMBS are fairly ahort-lived instruments; the typical effective maturity is five years or less due to sales and refinancings. And thanks to the Fed’s rate cuts, good borrowers will refinance, shortening the life of the pools and removing the better credits. These deals are somewhat seasoned, so the remaining average life in the part of the portfolio that is at the greatest risk is probably two to four years.
So back to Felix, what does the rally really portend? Most investors don’t know bupkis about the woes facing the bond insurer beyond the fact that downgrades would be Very Bad Indeed. I read it that the 125 basis point Fed funds rate reduction has revived bullish spirits a bit. As before, the market is interpreting news in a positive light.
And far more important, it really doesn’t matter what Dunton says but what the rating agencies do. S&P downgraded number four bond insurer FGIC on Thursday from AAA to AA, demonstrating that it is prepared to cut ratings, and came as close as it could under the circumstances to giving Duncan a slap. From the Wall Street Journal:
“Although MBIA has succeeded in accessing $1.5 billion of additional capital, the magnitude of projected losses underscores our view that time is of the essence in the completion of capital-raising efforts,” S&P said.
Coming within hours of Dunton’s pronouncement that MBIA has sufficient capital, this statement can only be seen as a rebuke.
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Gary Dunton, not Duncan.
?
eh,
Ooof, I need a line editor. The previous post (and I was working on it at the same time as this one) was an article by Richard Duncan. Proofreading is a big weakness of mine.
To give you an idea of how pronounced this mental defect is (and tell one on myself), I was once writing up a series of client meetings, one of which was in Venezuela. I had been playing Evita while working on the document. I sent a draft to the client, who wondered about the references to Argentina.
Thanks for the catch.
Either this is as clear a case of PPT-like manipulation, or Ackman and his team are incompetent and unethical. The fact that the mainstream financial press cannot seem to tell us which one it is does not surprise me (and goes some way toward explaining the rally), but I hope will open some eyes.
But what is even more surprising is that the markets bought this garbage barge…
As for the markets…
Go figure.
http://ftalphaville.ft.com/blog/2008/02/01/10652/monoline-bailout/
Only a flash, but CNBC were reporting at lunchtime on Friday that eight banks have clubbed together to bailout the monoline bond insurance industry, including: Citi, UBS, Wachovia, RBS, SocGen, BNP Paribas, and Dresdner.
Interesting that these are largely European names. More detail to follow, possibly
more details http://www.cnbc.com/id/22948246
I don’t know, but my reaction to this report is: now we know where the biggest losses will be. No bank will be in the bailout scheme unless there have a lot on the line.
Ackman is right and has been on the monolines for five plus years. Their business model makes no sense and never made any sense. What else can Dunton do but “shoot the messenger”?
The only thing a bail out achieves is that it continues the charade longer.
It is absurd for a private entity to even consider it.
If a hurricane hits and destroys my investment properties doesn’t it make sense for me to bail out my insurance provider?
After listening to all four hours of the call, one is no better off in feeling their way through the darkness. One has to belive that Ackman hgets the benefit of the doubt as it is he who has driven the forced disclosure that now seems to be coming grudgingly. If all was so great and in order, then MBI would have been out front of this long ago. MBI is desperate to protect the municipal business which is basically a risk free business, which begs the question of why it is necessary, other than as an inside subsidy for the municipalities. This whole NY charde is all about protecting the biorrowing costs of munis that are feeling the pressure from declining revenue and overstreched budgets. The more you watch the more disallusioned you become.
Is the actual risk in ‘cash’ being overlooked?
Mike over at HedgeFolios had an interesting perspective on risk in ‘cash and cash equivalents’. Auction Rate Securities followed up on an earlier post, Cash and Cash Equivalents where he talks about commercial paper, and the inclusion of corporate debt and asset backed securities in ‘cash.’ After what happened with Bristol Myers, makes me wonder just how hidden the problems are.
They are banking on future cash flow to save them as they ignore the reality of the present value and thus the reality that there will not be future cash flow!
Great illusions depend on not asking questions or seeing the trick up close too many times.
If a hurricane hits and destroys my investment properties doesn’t it make sense for me to bail out my insurance provider?
Actually it just might make sense, if that same insurer has written the policies on billions of other investment properties outside the hurricane zone, and his collapse would mean banks calling in all my loans. I think that is why it might (note I said might) make sense for the banks to keep MBIA and its ilk afloat today.
I also don’t see what’s so wrong about munis shelling out an insurance premium to lower their borrowing costs a few bps, as long as the insurer is sound and the muni is only a little less sound. Warren Buffett apparently doesn’t see anything wrong with this either.
YS, this was like a football coach calling for the hail-marry play
with time about to expire. The stock rallies on an implicit
admission that the game is almost over, amazing
hallucinatory powers of the buyers.
Maybe you can have drinks with your banking insider this weekend, and give us an update Monday?
How to lose $7.2bn with just a few Basic skills
SocGen: it could’ve happened anywhere – and still might
http://www.theregister.co.uk/2008/01/31/kerviel/
I also don’t see what’s so wrong about munis shelling out an insurance premium to lower their borrowing costs a few bps, as long as the insurer is sound and the muni is only a little less sound. Warren Buffett apparently doesn’t see anything wrong with this either.
Ok lets make it simple – muni gets lower cost of funding, buffet gets a risk freee premium and the bond buyer gets a lower yield. great for everyone but the investor and comncerned citizen, as that subsidy is facilitiating the destruction of your capital in the form of future taxes (borrowing). I’ll skip the discussion of the treasury market, but you get the drift
newsman,
The issue is that this is almost certain to be throwing good money after bad. Even though a downgrade of the monolines would be very damaging, the amount required to save their ratings (and we don’t mean for the next six months, but for good) appears by any reasonable calculation to be so large as to not be worth it,
Remember, the worst outcome is not to have the downgrade happen, if you are an investment bank. It is to throw a few hundred million at this problem and still have the bond insurers get downgrades, merely later.
As we noted above, Ackman’s estimates aren’t the worst out there. And the amount to save an AAA rating HAS to be greater than the amount needed to cover expected losses. Need to have a big cushion to warrant an AAA.
s,
There isn’t anything inherently wrong with muni bond insurance, except the reason it is a good business for the insurers is that the rating agencies grade municipalities tougher than corporates for the same default risk.
Why does everyone continue to portray the Muni business as “solid”
CDO’s were good investments 2 years ago too
Munis are going to start defaulting in droves due to decreased property and sales taxes, etc
Buffett will have a chance to price for these new defaults
Ambac and MBIA and the others have not.
The bailouts will never end — if they get by this shoe dropping, many more will follow