MBIA and Ambac: Edge of the Cliff, Ratings-Wise

From my RealMoney Columnist conversations yesterday:

  So yesterday Moody’s places MBIA and Ambac on Negative Watch. S&P grabs the ball and downgrades them, leaving them on negative outlook. I pointed out a while ago that the dike had been breached, and it was only a matter of time until the downgrades came.

And, as I pointed out yesterday, there will be new entrants to the market. Not only will Berky be there, with Assured Guaranty and Dexia, but Macquarie Group joins the party as well.

Even if Ambac and MBIA (the holding companies) survive, the business that used to be profitable for them will be occupied by others. I’ll throw this out as my next prediction in this space: they both go into conservation, and in runoff, claimants get paid off, senior debtholders get nicked, subordinated debtholders lose a lot, and the equity is a zonk.

Position: none

and

One last note: the stocks rally after the downgrade. Probably short covering and other derivative-related activity, but you have to admit it is amazing for the stock to go up when the franchise gets destroyed.

 

Okay, after yesterday’s piece, there was a fast, opportunistic reaction by S&P. Moody’s action gave them cover to downgrade, and S&P took the ball and ran with it. Now that action gives Moody’s the cover to downgrade freely. There is no longer any reason for them to stay at Aaa. There is no money in it, and their reputation can only take further his from here. Rating agencies are like wolf packs — there is safety in the pack. Don’t be an outsider.

From one of my old RealMoney pieces (12/1/2004):

Many of the conflict-of-interest problems still exist today. One more example: Could the ratings agencies downgrade MBIA (MBI:NYSE) or Ambac (ABK:NYSE) even if they wanted to? MBIA and Ambac rely on their Aaa/AAA ratings to the degree that they would have a difficult time operating without the rating. Much of the bond market relies on enhancement from MBIA and Ambac. The loss of a Aaa/AAA rating would be a jolt to the guaranteed bonds.

 In addition, MBIA and Ambac structure their risks according to models provided by the ratings agencies. It is the models of the ratings agencies that tell the guarantors how much equity must stand in front of the debt that is being guaranteed. The ratings agencies are an inherent part of the business model of the financial guarantors. MBIA and Ambac can’t get along without them.

The ratings agencies derive so much income from these major financial guarantors that their own financial well-being would be affected by a downgrade. I’m not saying that either should be rated less than Aaa/AAA, but there is a cliff here, and I am wary of investing near cliffs.

Well, we came to the cliff, and S&P shoved MBIA I(MBI) and Ambac (ABK) to the edge. Now Moody’s can push them over the edge. It should come soon. As with the rating agencies actions on the other financial guarantors, once a guarantor is pushed below AAA, the rating no longer matters as much. There are dedicated “AAA only” investors that care about this, and they will be forced sellers now, or, they will modify their investment guidelines.

Now, as I have mentioned before, stable value funds will have their difficulties here. Some have positioned themselves as “AAA only” funds, and that led to large holdings of MBIA- and Ambac-guaranteed debt. What they do now is beyond me. I suspect they try to modify their investment guidelines.

At this point, we have to contemplate life without the old guarantors. They will shrink and disappear, while new guarantors, who are all currently skeptical of doing much more than Municipal bond insurance, will grow, and make it impossible for the old guarantors to return, because they are much better capitalized. Once you lose your AAA as a guarantor, you will rarely get it back.

Comments

[oldlures1:]

The ultimate question is why are MBI and ABK losing their AAA rating? Is it because of financial fundamentals, such as captial adequacy, impairment points of sr (& super sr) tranches, claims paid (ie. true loss), and the like. Of is it based on broad-based industry observations, vague innuendos about what might be happening in the insured portfolios and predictions about waining future business (i.e. franchise value)?

With regard to my last point, I'd like to point out that MBI was the 3rd largest originator of bond insurance this year. But if you listen to the headlines, and follow the rating agency dictum, they're not writing any new business, at least not now...not that they're now downgraded.

I liken MBI and ABK to boxers; they're in the ring, fighting the fight, because that's what they do. This is tough fight, and they're taking some blows, but if left to fight a fair fight, they'll finish the bout a winner. Unfortunately, there are forces at work to ensure that they don't finish the fight. So ask yourself, who would want that, and why?

Policyholders are going to be paid; they were never in danger, and MBI and ABK's reputations were fine, that is, until they were trashed in the headlines. So why downgrade them? Why effectively take them out of the fight?

Did someone say there are new entries to the market? How interesting.

2008 Jun 06 05:40 PM

[crashof2008:]

By MBI's own admission in their last quarterly filing, new business was down 43%.

California, New York, New Jersey, New York City and now Florida have all decided not to use monoline insurance anymore. That trend is growing rapidly. Those are huge clients.

Soon all 50 states will simply issue bonds on their own full faith and credit just like the US government does.

It's far cheaper that way.

Monolines will default long before states do.

Why does MBI refuse to give an open accounting of what's actually going on in their offshore subsidiaries? What are they trying to hide?

2008 Jun 06 08:16 PM

[oldlures1:]

Crashof2008 - You're absolutely correct, MBI's new originations fell significantly this year. But in light of the bad press and mkt environments, does that really surprise you? I think what's important is that they're still writing new business...despite that challenging obstacles.

I also agree that many states aren't, at the moment, utilizing the monolines to credit enhance new debt issues, but I suspect you and I disagree as to why. It's not that the states don't want insurance per se, but it's simply too expensive at the moment. The lack of muni defaults has provided for a stable underlying/spur rating, but bond insurance premiums charged by the few players exploiting mkt conditions are exorbitant. As such, the minimal rate differential of AAA vs AA isn't enought to substantiate today's high premiums for credit ehancement. It's easy math and an easy decision, so the states are foregoing bond ins for now. But make no mistake, bond insurance is here to stay, and once the dust settles, and competitions returns to the mkt, premiums will drop, the economics of the deals will work and states will get insurance.

On the topic of muni defaults, I'd offer that you may see a increase in muni defaults. Over the past five yrs, many municipalities obligated themselves to many new projects, and the inherent funding obligations, based on tax revenue...revenue that is now falling. Keep watching the radar. If this happens, it'll reinforce the need/desire for monoline insurance.

Again, bond insurance is here to stay. After all, if it's such a flawed business model, why is everyone rushing to start their own bond insurer?

I'm not sure what you mean by "default" in terms of the monolines, but if you're opining as to their future insolvency, then I would disagee on that count as well, as their financial fundamentals (not media headlines) don't support this popular perception. In fact, based on the numbers, insolvency is highly unlikely.

I'm also not sure what you mean by "offshore". MBI has a number of subsidiaries domiciled outside of the US for the purpose of writing international coverage, which seems logical given the nature of the business. If by "offshore" you're referring to their one Bermuda subsidiary, CapMAC Asia Ltd., then I would offer that it's "accounting", as well as that of the other "offshore" subs, is incorporated and disclosed in the company's financials/10-K. With that said, Channel Re, a Bermuda-based reinsurer, has garnered some headlines where MBI is concerned. MBI is a 17% owner in Channel Re, but it is not a "subsidiary" of MBI, technically speaking, hence the reason MBI can't provide details of it. Unfortunately, that's not what you read in the headlines, let alone hear it in Bill Ackman's rhetoric. If Channel Re is a subsidiary of MBI, then Moody's is a subsidiary of Berkshire Hathaway (a 20% owner).

2008 Jun 08 10:25 AM

[FIG trader_:]

Oldlures1; wake up. do you actually think the "headlines" caused the failure. If you are still holding the bag, it will be empty soon. Only the last phase of the decimation for equity holders is probably due to "headlines". The business model is worthless, and William Ackman deserves star status for exposing the "investment farce". All the rest of your discussion, and that of 99% of commentators is worthless filler.

2008 Jun 09 08:27 AM

[River20:]

I agree with Oldlures1. Base on the fundamentals, I must say the possibilities for MBI to go insolvency is highly unlikely. By the way, the downgrade is mainly because of the worry of the ability(and cost) for future capital rising. It is mainly based on the given low stock price today and bad economic environments. The question here is that why these two factors should be consider at first place in order to rate a company? It was not used in the past, why now?

If you look at the ownership of the stock, you will also find interesting things. The insiders and institutional investors holds 113% of the outstanding stocks. It is over 100%!! Most of them just bought the stock in last 6 months and lots of them is for long term investment. As the short sell ratio is 16%, there is only 3% of the outstanding stock in normal investors hands. So, either the insiders and institutional investors are crazy (NOTE: Insiders bought over 20 million shares in last 3 months and a lot of institutional investors are top-tier mutual funds) OR there will be lots of blood from the short-sellers (Just think about how can they come up the 16% short from 3% normal investors' hands)

Will the muni-bond insurance business stay in the future? No one knows. However the fact is: In normal economic environment, the cost of using muni-bond insurer is much lower than issue the muni-bond with low credit rating. As long as the premium is reasonable and the muni-bond insurance can enhence the credit rating, there is no reason for muni-bond insurance disappearing.

2008 Jun 09 11:40 AM

[User 165905:]

You should all double down right here again, which I am sure you have all the way down. MBI and ABK are below IPO prices of 20 years ago, and have lost everything for investors, even those who bought in 1998. You have to try real hard to lose everything, and cumulatively show less than 2% annual total return since inception (dividend mostly). Any body that bought after 1990 got skadooch!!!!
There is a better chance of seeing zero than seeing 4 or 5

2008 Jun 09 03:21 PM

[vittello:]

Everyone is missing the story here. Up until about a year ago, MBI and ABK were blue chip companies with a nice stock price and a quiet, well managed business. Then they, along with many others, insured a wall street product blessed by the major ratings agencies as recently as last summer. Having rated structured finance in various forms for the past few decades, the ratings agencies will state that they were more than competent to judge the tranches individually and the CDOS as a whole. As the NY AG pointed out last week, these agencies were working too closely with the banks on getting products of a certain high grade to the market whether they deserved it or not. So, ABK/MBI et.al insure the products based upon the ratings assigned-shortly thereafter, the ratings on these tranches start to decline and the insurers are now sitting on a rmbs cdo portfolio of junk for the most part. Fortunately, companies like ABK have the reserves neccessary to maintain a AAA rating and decide to protect those reserves by choosing to not write new business which would have required them to raise their reserves, thus jeopardizing their ratings again. If you check their website and review their June 4 presentation, you will get an accurate, timely insight into the company. Just after this presentation, the ratings agencies attacked them out of nowhere and raised the bar on them. In the meanwhile, wall street has been steadily, building up the short pressure on the share price. Why? Because ABK started to indicate that they would contest claims (even though they have plenty of invested capital to handle these interest/principal payments as they come due over the next many years) and hand the bag back to wall street/ratings agencies. As the ratings agencies have very little in the way of cash reserves, it's basically to the street-which some say could be on the hook for another $300B in writedowns. ABK will state that they have about $400m a year for the next few years in insurance premiums guaranteed, as well as around $1B of investment income annually for the next few years-and have 4X in reserves needed to pay this years maximum potential claims. Ex-unrealized losses and gains, their stock has around a $30/sh book value. Once the insurers, ratings agencies and wall street make a deal to get through this, they will and ABK will return to it's former glory within a few years. Short-term bankruptcy is out of the question, unless they are mis-reporting figures, or a new catastrophe arises.

2008 Jun 09 03:46 PM

[oldlures1:]

Vittello -- good argument, and well-made.

2008 Jun 10 06:53 PM

[User 165905:]

Vittello; Perhaps you should let us know whether you have any skin in the game, and what price you paid. That would say a lot about your money management skills and risk tolerance. Since you seem to know the story going back years, I assume you paid well above $2 a share (someplace between 2 and $30, or was it $50). And in either case, why don;t you refinance your mortgage (say 400 grand could give yu another 200K in ABK shares), put some additional funds as of today, to show your conviction. People want to know.

2008 Jun 11 05:39 AM

[EnforceTheLaw:]

User 165905: You are missing the big point. Vittello and anyone else who invested years back are the victims, just as ABK and MBI are.

I mean victim in the literal sense. Wall Street invented the garbage and the ratings agencies were negligent in rating them. Wall Street, as usual, is now trying to profit by buying the garbage they created at pennies on the dollar to re-sell it at a handsome profit.

It has been that way forever. What is different this time is systemic fraud and glaring spotlights.

Vittello is 100% correct -- the rating agencies, who have already proven their competence -- are trying to execute ABK using a firing squad formed in a circle. At minimum, they have again proved they don't have a clue -- just a couple months ago they demanded that ABK and others raise capital, which they promptly did.

So, were the raters incompetent when, A, they first issued the ratings; B, when they demanded more capital; C, or now; or, D, all of the above.

It is the rating agencies whose business will be destroyed in the end. If they were not culpable, they should be joining ABK in attacking (and seeking compensation from) those that misrepresented what was being rated / insured.

btw, if the banks face $300B in losses -- and extending the financial system turmoil -- you would think the smarter banks would contribute capital to ABK to meet the latest rating agency rant.

Don't get me wrong... these are risky shares and I having been building a position only recently writing cash covered puts and trading calls on the few shares I own. I treat them like an unexpiring option.

Also, with regard to recent weakness: on the 10th ABK was pulled from the SP500 index.

2008 Jun 11 10:23 AM

[User 165905:]

P14911; You are missing the point; Who are you referring to when using the name "Wall Street". Certainly you can't be excluding the ratring agencies and the monolines themselves, or the banks that refuse to put up more capital. Why should JPM bail out the losers for making bad bets. Who is deceiving who. They are all getting shown the door Wall Street (LEH, BSC, MER) the banks, C, WB, WM, the monlines ABK, MBI, and anybody else that played the dangerous game. Is Vitello and oldlures innocent, well they are big boys if they are speculating on the junk, and should take their loses like men. Bt saying these dogs will return to their glory days and giving bad advice just has to be refuted. He gives no real argument; the days are numbered, and new names are being sent to the firing squad as we speak.

2008 Jun 12 08:02 PM

[User 214231:]

Vittello, I agree with you. I'll bet there is a democratic power structure in the agency that down rated MBIA. I think you said somebody possibly is out to get MBIA and the others. I still stand on the thought that the democrats are still trying to keep the market down any way they can. I've said this before and I will repeat it, my friend many years ago, a black man I worked with told me one day at work, "Gary, I'm a democrat, and I don't care if the democratic party runs a jackass for president, when I go into that booth I'm voting for the jackass". I'm not implying in any way that remark towards Boka, but he is so liberal I cannot believe any of the warriors of WWII would cast not even one vote for him. Those were the bravest most heroic men. Men to be honored and respected, men who put America first, even before their own lives. I believe each and every one of those warriors would never, never vote for Boka after his one remark made in the beginning of his campaign. That was, "If I'm elected president I'll bring the men home from Iraq, no matter what". That would be such a disgrace to every man who has died, every mother/father who has lost a son/daughter, every wife who has lost a husband. Is Boka too blind to see that every terrorist who has died in Iraq is a terrorist who will not terrorize in America? I'm not very smart but even I can see the wisdom in that. If by some evil act of Satan Boka is elected president, then you can look for the most tragic days ever to be recorded in American history. I pray for the American voters often, praying that they will have the wisdom not to vote for a party, and to vote for the plan. The fate of America depends on whether the democrat is willing to vote for America, or if they feel like my friend who was willing to put a check by the square, voting for a jackass, just because it was a democrat.
The market will take care of itself after the election. Things will then be normal again. Three A ratings will be reestablished, and then you'll know.

2008 Jun 22 08:06 PM