MBIA Refuses to Downstream Cash, Uses CDS Fears to Defy Regulators

Let me tell you, if we have a revolution in the next decade, one of the triggers will have been the flagrant disregard shown by big players like MBIA for regulations, legal commitments, and fair dealing. I’m not surprised to see financially oriented sites calling for mass protests (but not yet against bond guarantors).

The latest bit of MBIA chicanery manages to sink far beneath the already low standards set by the bond insurer. Readers may recall that MBIA had refused to downstream $900 million raised in highly dilutive equity offerings to its insurance subsidiaries (note it had raised $1.1 billion, all of which was initially slotted to go to the subs, then when it was revealed that the money was still in the holding company, said in early May that they would remit $900 million to the insurance ops, then in early June basically said that they had changed their mind). As we noted last week:

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…..

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.

So why hasn’t Eric Dinallo, who is unusually pro-active for an insurance regulator, taken MBIA management out and shot them by putting the company in runoff mode? (Note he is almost certain not go that far, but he has that as the big gun in his arsenal.) MBIA has booby trapped itself. As the New York Times reports:

MBIA has written $137 billion in swaps, which are privately traded insurance contracts that let people bet on companies’ financial health. Most of these contracts stipulate that if MBIA’s bond insurance unit becomes insolvent or is taken over by state regulators, buyers can demand payment immediately.

But if that were to happen, MBIA would have far less money to pay policyholders and owners of municipal bonds backed by the company. So the swaps give MBIA significant leverage over Eric R. Dinallo, the commissioner of the New York State insurance department, who wanted the company to bolster its insurance unit with the $900 million in cash.

In the case of Bear Stearns, the Federal Reserve feared that credit default swaps might unleash a chain reaction of losses if the bank were allowed to collapse. Given the threat that similar swaps may pose to MBIA, Mr. Dinallo is unlikely to push for a regulatory takeover of the subsidiary even if Joseph W. Brown, MBIA’s chief executive, refuses to recapitalize the unit…..

Mr. Dinallo said he could refuse to honor acceleration demands if he took over a bond insurance firm, but such a move would almost certainly prompt investors who hold the credit default swaps to press their cases in court. The acceleration clause is a standard feature in credit default swaps written by many bond guarantors, including Ambac and the Financial Guaranty Insurance Company.

How could people this dishonorable ever gotten themselves in charge of anything more consequential than a used car dealership? The excuse is that MBIA now plans to start a new subsidiary, but given that that the incumbents mismanaged MBIA so as to lose its AAA ratings (Moody’s has not officially lowered the boom, but its downgrade is widely expected), reversed themselves on actions that their regulator required and they agreed to, and are now in open defiance of their regulator, do you really think they are going to get approval to start a new subsidiary? This is clearly a stalling action to keep as much cash as possible at the parent level to maintain the employment of and benefits to the executives.

Dinallo nevertheless appears to be giving the outrageous, self-serving MBIA proposal some consideration, provided the new sub resinsures the muni bond guarantees of the existing insurance operations, However, it’s one thing for him to keep talking, another thing to take action. I wish there were a way for him to force the removal of the current management without putting the subs into runof. Industry old hands see through this malarkey:

John Miller, chief investment officer at Nuveen Asset Management, a big municipal bond fund manager in Chicago, voiced skepticism about MBIA’s plans to start a new insurance subsidiary that could reinsure its existing portfolio.

“It would be surprising to me if it would be successful,” Mr. Miller said. “It will still be an MBIA-insured bond and then reinsured also by MBIA, but MBIA as a new company.”

Some believe this tactic is self-defeating:

Joshua Rosner, an analyst at Graham-Fisher in New York, said, “It seems to me that if Jay Brown insists on putting the money anywhere other than at the insurance subsidiary or through a new subsidiary directly under it, he is making a very clear statement that he no longer believes in the viability of the insurance company to meet its obligations.”

Unfortunately, no matter what the outcome, this sorry saga has a few chapters to go.