MBIA Earnings: Disappointing but No Cause for Alarm

MBIA (MBI) reported after the close of business Monday GAAP EPS of 3.34, an upward surprise. However, mark to market accounting has the effect of requiring the company to mark down its derivative liabilities to reflect the market's perception of their ability to pay. The more accurate measure is the change in nonGAAP adjusted book value - ABV , which was a loss of 2.45, declining from 40.06 per share to 37.61.

I listened to the conference call. President and CFO Chuck Chaplin pretty much led with his chin by opening with a remark that results were poor. Honest enough, but not something to raise share prices. Analyst questions seemed to focus on accounting details, picking and pecking at the various difficult areas on the balance sheets of the three subsidiaries.

Ineligible collateral - What I got out of the call was an overall impression of the importance of litigation to the immediate prospects of the company. They are suing ResCap, Countrywide and Merrill Lynch over the inclusion of massive amounts of ineligible collateral in the bonds MBI insured. They also have presented a claim to the FDIC on Indy Mac for the same problem. The complaints are available on their website, and I have read large parts of them, tedious as they are. The simple takeaway, that it's about the inclusion of ineligible collateral, is very helpful. The amounts involved are somewhere between 2/3 and 80% of MBIA's total losses arising from the financial crises, which works out to around 2 billion.

Article 78 - Not discussed on the conference call, but mentioned in the press release, was a simple statement about suits by Aurelius Capital Partners and Third Ave Value Fund, both seeking to reverse the transformation whereby MBIA's structured finance and municipal bond operations were placed in separate subsidiaries. The point is, that the proper approach legally for either of these companies would be an action under Article 78 of the NY State law, which is about efforts to reverse administrative decisions. Because the transformation was done under the supervision of the NY Insurance Department, after a careful consideration of the facts of the case, the burden of proof to overturn it is substantial.

Market response - puzzling to me. The stock had been trading up for a week, and when the earnings came out after the close Monday it got up as high as 8.68 on respectable volume. With the volume as high as it was, I figured the after hours crowd would define the market reaction, but when it opened Tuesday morning, it was quickly driven down to as low as 6.39 on high volume, over 11 million shares within an hour for a stock was averaging 4 million shares a day not that long ago. The short interest on MBIA is huge, presumably hedge funds and other savvy predators, so that is a drawback for me as a small retail investor: I am playing in heavy traffic, and the SEC does not have my back. I learned that last year, to my sorrow.

Options strategy – With that in mind, I have been playing this situation in options, short May and June 5 puts and long May and June 7 calls, on a ratio of 1 put to 8 calls, positions I established when the stock stood around 4.30 per share. The idea is to use the proceeds of selling puts to fund the calls, resulting in little if any cash outlay and the possibility of large profits if the stock makes a large upward move. Specifically, it will benefit from a short squeeze if and when that phenomenon develops.

As the stock ran up last week, there was quite a bit of demand for the May 7 calls and I closed most of the May position at a good profit, not neglecting to buy back the puts. I held back a few of the May calls in case the earnings would be something exciting, but yesterday I sold them for what I can get because, with expiration coming up Friday, time is growing short.

After thinking a bit, I also closed the June position, at a fine profit: I would prefer to watch the market action of short-sellers with my money in my pocket. No short squeeze for me. Not today, anyway. If they drive the stock back down to where it was I will set my options position back up along the same lines as before, and continue waiting for the big pop. The yield on the adventure was 4,500%, for a two or three month effort. This does not make me whole for what I lost playing buy and hold with the stock last year, but it does make a decent down payment.

Target Price and re-entry points – my best case target would now be the ABV, 37.61. A good re-entry point would be 1/8 of that, or 4.70, not unlikely if the financials do a pullback, return to reality now that the bank stress tests are done.

Comments

[Ishortyou:]

your strategy looks appealing shorting and longing at different time frames seems to be reasonable, I never tried shorting because of the high risk that implies but I might give it a try with small 'pocket change' capital at that recommended ratio and see how it goes, the other thing is how MBIA is going to bump up the new subsidiary's rating to triple A to start new business in municipal bond insurance?

May 13 07:54 AM