MBIA’s conduct continues to be shameful, yet the company is not getting the pillorying it deserves, at least from the media. Its latest bit of misbehavior: the company has reversed itself on its decision to remit $900 million of the proceeds of highly dilutive fundraisings to its insurance subsidiaries.
Why might that be? Well, the big bond insurer looks just about certain to lose its last AAA (Standard and Poor’s and Fitch have already cut the rating on its insurance sub to AA; Moody’s has MBIA and Ambac on negative watch, and given the actions of the other two agencies, the odds that it will follow its peers is high).
If the companies lose their top ratings, the odds also increase that they will be put in runoff mode, which means they cease writing new business, cut their parent company operations to the bone, and do the best they can to pay out existing agreements.
So what has MBIA done? It’s reversed its decision of May and contrary to the spirit (if not the letter) of its capital raising, is retaining proceeds at the parent level. From Bloomberg:
MBIA Inc., downgraded from AAA by Standard & Poor’s last week, hasn’t given $900 million to its insurance unit as planned and said it is now re-evaluating its business strategy and capital deployment plans.
“Our landscape has changed,” MBIA Chief Financial Officer C. Edward Chaplin said today in a statement distributed by Business Wire.
We weren’t too happy when MBIA said earlier it wouldn’t wouldn’t downstream the cash (note the amount at issue then was $1.1 billion. On May 12, the company announced it would remit $900 million to the insurance subs, so the intent then was to retain $200 million at the parent level). This post came a few days before, when it was revealed that MBIA was retaining cash at the parent level):
MBIA has brazenly advanced its own interests at the expense of investors and policyholders. A partial list:
Issuing a disappointing earnings release in the middle of the night in the hopes that it would garner less attention that way
Asserting it needed no more capital while the Dinallo-led “save the monolines” effort was still underway. CEO Gary Dunton’s claim was so patently bogus that it stirred the normally circumspect S&P to issue a swift rebuke
Telling the one major rating agency that has the guts to give the bond insurer the less-than-AAA it deserves to take a hike (fortunately, Fitch is ignoring that directive)
Admittedly, some of these unsavory actions took place on ousted CEO Gary Dunton’s watch; we now have Jay Brown in charge. However, old habits die hard.
The latest stunner is that the money raised in MBIA’s last, hugely dilutive equity sale is being held at the parent company. For those who have not followed the monoline saga, that’s scandalous.
The whole purpose of the fundraising was for the parent to then downstream the proceeds to the insurance subsidiaries. That’s where the insurance is written, that’s where the capital shortfall is.
So why is MBIA hoarding cash at the parent level? Well, executives (along with other corporate charges) are paid out of the parent company’s books. The subsidiaries can dividend cash up only if the are profitable OR get permission from their regulator.
The big bond guarantors have been notably loss-making of late. Eric Dinallo says that both MBIA and Ambac may need to raise more capital. The monolines’ business model is toast. The structured finance business involves bona-fide risk transfer, and the bond guarantors’ capital bases (equity is less than 1% of assets) is far too thin to allow for that, particularly when an AAA rating is essential for conducting business; the nearly risk free ratings arbitrage in the muni finance business is going the way of the dodo bird (and with local government budgets under stress, even that old supposedly cosmetic credit enhancement may wind up leading to some unanticipated losses).
So how does the hoarding of cash fit into this picture? Well, Bill Ackman, the hedge fund manager who was leading the campaign against the monolines, argued that they should be put in runoff mode, with the investors at the parent level sacrificed to preserve the claims-paying ability of the subs. That’s a course of action the regulators would almost certainly arrive at on their own if they thought the bond insurers were in peril.
So what does the holding of so much cash at the parent level mean? Aside from being a shameless case of duplicity, it says one of two things, neither pretty. First, they expect losses for the foreseeable future, and expect the regulators to prohibit dividend payments too. But withholding the entire $1.1 billion is an admission of how bad they expect things to get. Or second, they expect the regulators to put MBIA into runoff mode, and are keeping their cash to support the parent level empire that would otherwise be starved out of existence. But if so, the representations made by management about the soundness of the company are false.
No matter how you slice it, the sequestering of funds is wildly inconsistent with management’s position that MBIA has a good future, or indeed any future at all.
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Haven’t the monolines been floating the idea of starting new subsidiaries? Sort of like the good bank / bad bank model that was used during the S&L crisis of the 1980s — stick the bad bank with the non-performing loans; let the good bank write new sound business with prudent risk management. They might need the $1.1 billion to fund the ‘good monoline.’
What would be outrageous, if that’s the plan, is letting the same management which wrecked the ‘bad monoline’ seamlessly segue over to run the ‘good monoline’ — and probably collect both severance and signing bonuses for doing so. Fortune favors the bold! And the shameless …
That idea was presented, not by the monolines, but during the discussions sponsored by Eric Dinallo. I haven’t seen anything from MBIA that says that they are contemplating that idea (but it is possible I somehow missed it).
Moreover, the old idea was to split the ‘bad” structured finance business from the “good” muni bond business. The muni bond business exploited a defect in the ratings agencies’ processes, namely, that they graded the municipalities more harshly than corporate issuers. They are being heavily pressured by Congress and have said they’d stop doing that. Plus state and local government budgets are under tremendous stress right now.
And most important, with no AAA, they have no business at all.
Long way of saying I don’t see how this idea could be implemented with the current fact set.
This raises an interesting question for the CDS market. Most protection was purchased on the holding company. By not downstreaming the $900mm capital, does that mean that the holdco is now highly creditworthy, while the insurance sub is toast?
The homeless guy on the street told me he was going to buy food with the money that I gave him.
Didn’t Ambac and MBIA also write a lot of GIC’s with downgrade provisions? Usually, they would be required to put up collateral if their ratings fall below AA – or pay the money back.
Were I Dinallo, I would refuse to allow them to set up a new monoline. He has that authority for his own state. I might also take the existing companies into conservation. Then, let MBIA take their spare capital and try to set up a monoline in another state.
The commissioners of the other states should refuse them as well, because they mismanaged an insurance company already. They are supposed to check these things when new insurance companies are formed.
Finally, I’m not sure how much good $1.1 billion will do them — If you look at the 2007 10K (page 161), and wipe out their investment in subsidiaries, and take the first quarter $2.4 Billion loss out… let them have the $1.1 Billion, their net worth is still negative.
Now, maybe the loss is at the subsidiaries, so their net worth at the holding company would be near zero. That would still cause them to violate the minimum net worth covenant on their bank debt, if they lost control of their subsidiaries.
The banks could force repayment, and if I were a leading bondholder (calling the major life insurers), I would have one of my lawyers make a courtesy call to MBIA’s lawyers, and suggest that any payment of bonuses could be viewed as fraudulent conveyance.
MBIA is in a bad enough spot, that I don’t see what good keeping the $1.1 billion does them in the long run. Thus, it has to be a short-term gambit.
Is it possible the monolines will be “saved” on this on-going deathwatch, while WM goes under with 45,000 employees?
Politics and madness? Where is that retard from Fox or whatever, Charlie?
Why do you seem so suprised? Unfortunately , this is a slow motion train wreck. This management is shameless and as they see their company going the way of the dodo, they will do everything to preserve their fat paychecks and soft bonus structures. Ackman outted these guys long ago, he deserves every penny he makes.
Funny how the 90s was characterized by these great sermons about big spaces and big thoughts. The decade of schumpeter. Oh the web they weaved…
If I were an investor who invested I’d have to seriously think about suing management for fraud. And if management made no representations about how the cash would be used then nobody has anything to complain about — this move is obvious. Public companies don’t exist to serve shareholders, they exist to serve management. When was the last time a failed enterprise recognized that fact and simply wound up and paid out the profit?
GM should have done that a couple years ago when it had billions more in cash.
I’m not really sure why stocks go up when it is so incredibly difficult to get the money out of the corporations. I can see why taking companies private is so profitable.
MBIA’s prospectus supplement for the $1.1B offering states: “The net proceeds of this offering and the backstop commitment shall be used to support our business plan and operations.” (http://sec.gov/Archives/edgar/data/814585/000119312508025162/d424b5.htm#tx76189_4, “Use of Proceeds)
That’s “shall”, not “are currently intended to.” They mention no possibility that they might fundamentally change their business plan and operations; the tenor of the pro supp (and the offering) is instead that they’ll maintain their current business plan, operations and ratings by means of the offering and the backstop commitment.
Section 17 of the Securities Act makes it “unlawful” (i.e., criminal) to obtain money in the sale of securities “by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.” Section 12 subjects any person who sells a security “by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading” to a claim for rescission. Then of course there’s Rule 10b-g (to the same effect as Section 17). All very basic securities laws: omission is as bad as commission.
If MBIA persists, I foresee (a) suits by shareholders who bought in the offering (especially beneficiaries of MBIA policies, including their swap counterparties), (b) derivative suits by MBIA shareholders against the Board for authorizing retention of the proceeds by the holding company, (c) suits by beneficiaries of MBIA policies as such (including swap counterparties), (d) potential regulatory action against MBIA the bond insurer and (e) potential regulatory action or possibly even criminal charges against MBIA the holding company by the SEC. Of interest: the directors and signing officers (probably Jay Brown and the CFO) are personally liable for securities law violations if they signed (or didn’t object to) the registration statement, and the SEC doesn’t necessarily think the company can indemnify them for that liability.
From a legal perspective, fascinating. From MBIA’s perspective, if it were me I’d probably reconsider.
As for Jay Brown versus Gary Dunton: it was Jay Brown who was in charge when MBIA set up Channel Re and invented a “creative” treatment of their AHERF losses – and when Ackman started his crusade. In other words, I think Dunton’s management was mostly consistent with the pattern set by Brown, so it’s fitting in a way that Brown is there again now, when the chickens are coming home to roost.
I’ll add, though, that I’m not yet convinced that the insurance company is insolvent. I think it will be able to pay claims on a timely basis. The holding company is a different matter.
Great comments, thanks.
Per reality-based lawyer, it will be amusing to see the fur fly….and Ackman’s position is the same as yours. HIs point was the holding company ought to be toast. The monolines will clearly fight any claim under the insurance policies they reasonably can, so the fate of the insurance subs hinges at least in part on the success (and cost) of their litigation strategy.
(disclosure: I’m an Ambac shareholder)
What makes you think that they are not acting in the shareholder interest? Stop painting a misleading picture as if this is some sort of wiked managment scheme to loot shareholders or the public.
The capital was raised to sustain a AAA rating–nothing more. If I’m not mistaken, that’s one of the key reasons cited for the capital raise (among others). It was not done to pay capital shortfalls for any claims or anything else. MBIA is way over the regulatory capital requirement and any rating agency requirement too (that’s why they are rated AA and not CCC for instance).
You seem to mistakenly think that this money belongs to the government (i.e. politicians and regulators), policyholders, or various other counterparties. Nothing is further from the truth. It was raised by the company and belongs to the shareholders until it is given to the insurance subsidiary (at which point the regulator has control.)
In addition, several key shareholders (such as Warburg Pincus and Third Avenue) owns a huge chunk of the company. So don’t you think management is influenced by them to act in the shareholder interests? Or are you saying that management is doing this contraray to all those shareholders? A huge chunk of Jay Brown’s net worth is supposedly tied up in MBIA, and he keeps buying shares in the open-market as well, so I fail to see much conflict.
Claiming that capital that was raised (i.e. money paid by shareholders) is being held by the holding company is “scandalous” either shows that you really don’t know what you are talking about, or you misspoke and could care less about investors.
Having said all that, I think the surplus notes, which are backed by the insurance subsidiary, may possibly have to be given to the insurance subsidiary. But even then, it’s difficult to see how the regulator or anyone else can block these moves when MBIA is (i) cannot be shown to be insolvent (either by rating agency standards or insurance regulatory standards),(ii) hasn’t defaulted/missed payments on any claims, and (iii) cannot be shown to lack enough capital to pay future payments for already booked credit impairments.
Finally, I hope I’m not misrepresenting your stance, but you seem like someone who is pro-intervention and seeking further government involvement in financial affairs, and as someone who is setting himself up to rise and fall with the sword of the government, how come you never blame the regulators for any of the problems? If MBIA, or Ambac, or FGIC, or whoever else, actually doesn’t end up having enough capital, shouldn’t some blame lie with the regulators? Or are the government agencies and politicians too close of an ally for you? Pinpointing the mistakes made by the regulators is not going to solve the problem but it will avoid anything in the future.
It’s clear you are not a fan of the monolines and that’s perfectly fine (some people, William Ackman and David Einhorn foremost, think this industry is nothing more than a scam to rip off municipalities). But claiming that this is some sort of evil scheme by management, or that this money somehow does not belong to the shareholders (i.e. hodling company) is ridiculous. I’ll give you the argument if you limited it to the money that was raised through the surplus notes but the share issuance belongs to the holding company until it decides what to do.
(I apologize for attacking you Yves. I generally respect your views. Your blog is very good and I like your thinking (you do bring a differing take on many things). But it just seems that the problem is that many don’t have any skin in the game. It’s easy for you gals & gals to bash Ambac or MBIA or Lehman or Bear Stearns or whoever-else-seems-unpopular without anything substantive. Some of you are short-sellers so it’s understandable what you do to make money. But the rest clearly have no idea what they are saying, doing, or representin’ )
This is why I’m so disgruntled with this post and think it is totally misleading…
ANON: “If I were an investor who invested I’d have to seriously think about suing management for fraud. “
Obviously you haven’t been following the situation closely. I’m speculating a bit but… What MBIA is doing is GOOD for the SHAREHOLDERS. I’m an Ambac investor and I wish Ambac still held onto its money. The people who say otherwise are not looking at it from a shareholder point of view.
Although it is possible in the off-chance that management is looting shareholders, I highly doubt that is the case here. I would rather let management do something with the money than the politicians/regulators. I can’t remember exactly but almost half the board of directors is from Warburg Pincus (majority owner) and I doubt this is some nefarious plot by management somehow bypassing the board.
By Yves portraying this as some management scheme, he totally misrepresents the situation. Keeping the money at the holding company is good for shareholders. It may or may not be good for other parties but it’s the shareholders that money (except for surplus notes, which are issued by the insurance subsidiary and are quasibond-equity instrument).
Moody’s only having AMBAC and MBIA on negative credit watch but still maintaining a triple A rating is tantamount to not declaring an emergency as the titanic is sinking until the bow is completely submersed and the ship has a 45 degree roll. They have been deliberately stalling and still are as they are fully aware of the repercussions. Too bad. It’s about god damn time people start obeying the rules and let those who abused them suffer.
Live by the agencies, die by the agencies… the monoline business used to be a matter of eking out excess returns within the cost of capital guidelines set by the agencies. Some (well, well over half) of them took an arbitrage between the agencies’ take on credit risk and the markets, and played games with the agencies’ take on credit risk. not unlike the entire structured finance market. So to the original underwriting screw-up we add the fact that no-one knows what the agencies’ guidelines are any more. Do the two remaining monolines (FSA and AGO) prove that the agencies’ cost of capital recipe works, and their only screw-up was in rating structured finance bonds, or do we start asking questions about the value of the agnecies’ analysis everywhere in insurance?
i cover the monolines (and other specialty finance companies) on the equity side for a living. we have never owned the stocks and didn’t participate in the deal.
that being said, i think Jay Brown and his team should be commended for withholding the $ from opco. in my opinion, the run off value of the entities likely supports a higher price than the $12/share at which the capital was raised. the problem MBIA (and ABK, to some extent) faced is that the holding company liquidity was constrained by the problems at opco. without some forebearance from the regulators, the holdco’s faced significant liquidity issues over the next 5 years as long-term debt came due.
realty-based lawyer seems to fundamentally mis-understand the corporate structure of these entities. the underwriting company is a wholly-owned, bankruptcy remote subsidiary of MBIA corp. an equity holder of MBIA does not own a direct interest in the writing company; instead, s/he owns shares in a corporation that in turn owns the shares of MBIA Insurance. so when the prospectus language reads “the net proceeds shall support *our* business plan”, they are talking about holdco, not opco.
i am hard pressed to understand why injecting $900M of capital into an insurance company with unquantifiable liabilities and hostile regulators is a sound investment. the fact that they are willing to now play hardball with the regulators and rating agencies is a positive if you own the equity.
it’s a shame the banks don’t have the guts to call the government’s bluff the way MBIA is. the capital raises that the industry is undertaking are shameful. the *right* thing to do is shrink these balance sheets and constrict capital to the economy. that will dramatically improve margins and enable the industry to return to profitability much more quickly than it otherwise will.
hi david, I agree with you, that if I were ny state regulators, how I would be able to allow mbia to start another business. If in bad times they were willing to allow their noteholders and clients fall into the wind. And that they have reneg on their deals with regulators. Theres no trust, and in the business of insurance its all about trust. If you put out the public outcry,about the situation it would be impossible for regulators. it would be a pr nightmare. And if I were a ratings agency, it would be tought to justify giving them aaa. Also one note, if I were a regulator, or a rating agency, I would be scared like crazy to think that management is thinking about putting their scarce capital in buybacks or large dividends to shareholders, in a time of crisis. If I were a cynic, this would be an attempt by management to bail out their losing stock positions, and not to save the company.
This is hardball guys and gals. MBIA might show up with lots of third party investors and start a whole new insurance company. Capital adequacy will likely be such that it will be hard to deny them. There are plenty of value creation activities MBIA could engage in. You do not have to like it-but then the shorts thought the game only went one way.