Editor's note: Article updated with the author's revised version on June, 18 2008.
There are a lot of things I like about hedge fund manager Whitney Tilson. He’s a smart, articulate, and energetic man who devotes an enormous amount of time and energy to many worthy causes. He founded the Value Investing Congress, which is rapidly becoming a must-attend event for value investors, and has kindly asked me to speak at it. And Whitney has certainly had his share of success as a value investor himself.
But there’s one area in particular that Whitney and I differ: our views on financial guarantors Ambac (ABK) and MBIA (NYSE:MBI). Whitney has earned a great return over the past six months (and longer, I suspect) being short the companies. The fund I run has been long recently, and our returns have suffered. But I believe the short-run returns will reverse as the companies’ fundamental business prospects become better-understood and fears about their future losses and alleged liquidity constraints diminish.
As it happens, Whitney is no shrinking violet when it comes to sounding off about companies he has strong views on. He sends out an email daily to friends and associates that highlights news articles he finds of interest, along with his comments. For months, the emails have contained a steady drumbeat of abuse against the guarantors. I’ve read a lot of stinging attacks against company managements over the years, and have written more than a few myself, but I can’t recall anyone who can match Whitney Tilson’s ability to ratchet up the level of personal vilification against corporate executives he doesn’t approve of. It’s really quite something.
Another of Whitney’s emails arrived on Wednesday; it led off with yet another whack on Ambac and MBIA. Normally, I let the attacks pass. Disagreements are what make markets, after all. But this broadside was so unfair, misleading, and factually inaccurate, I can’t let it pass.
A letter to shareholders
Whitney’s comments on Wednesday had to do with a letter MBIA CEO Jay Brown wrote to his shareholders this week that discussed the recent credit rating announcements by S&P and Moody’s. (S&P recently downgraded MBIA’s insurance unit to AA, you may recall, while Moody’s put all MBIA’s units on review for a downgrade.) As it happens, those moves caused the company to change its plans regarding what to do with $900 million it recently raised in an equity offering. When the company was still AAA, the company planned to downstream the cash to its insurance subsidiary to help maintain the rating. Now, though, it’s considering alternatives.
Notably, in their announcements, Moody’s and S&P cited factors other than capital adequacy, such as lack of new business and continued uncertainty in the housing market, to justify their decisions. In fact, the agencies had to cite something besides capital adequacy, since both Ambac and MBIA exceed the minimum capital level required by both rating agencies for triple-A ratings. What’s more, those capital ratios are rising, as old risk exposure runs off and little new exposure is added.
Anyway, back to Whitney’s email this week, in which he wrote that Jay Brown’s letter was worthy of comment because it illustrated what Whitney believes to be the company’s arrogance and lack of candor.
Huh? I don’t know if Whitney has ever even met Jay Brown. But I do know Whitney can’t know him well. Jay is a smart, clear-eyed, common-sense operator, and the perfect person be leading MBIA right now. MBIA might have issues, but arrogance and lack of candor aren’t among them.
Next, Whitney slams the company for changing its plans for the $900 million. He argues the company once said it would downstream the cash, and is outraged it has had a change of heart without (until now) informing investors, customers, the rating agencies, and regulators. He then suggests the company’s actions might constitute fraud and market manipulation.
Say what? That’s as harsh as it is inaccurate. Here are the facts. Management only expressed an intention to downstream the $900 million, and didn’t do so right away so it could receive more clarity on future actions by the rating agencies. The New York State Insurance Commissioner was certainly involved in the discussion of where the money would go, since one of the company’s options under review was (and still is) the possibility of downstreaming the $900 million into a new subsidiary to write new business. So this is not fraud and market manipulation. It’s simple, above-board capital allocation.
Whitney goes on to claim MBIA has denied policyholders money that’s been promised to them so that management can keep their jobs. Policyholders are thus “screwed.” He then ends his tirade with a nice piece of thundering self-righteousness:
MBIA seems to have forgotten that they're a regulated entity and that they're not allowed to balance their "obligations to policyholders with optimizing returns to our shareholders". The deal with any insurance company is that policyholders come first and only if there's money left over does anything go to the holding company, which is why MBIA is [likely to fall further] and why we're still short it.
The good news is that, based on what I've read, NY State Insurance Commissioner Eric Dinallo is on to these guys and I assume won't allow these . . . actions.
Whoa! Can we get back to Insurance 101 for a second? Whitney surely understands the difference between a holding company and an insurance subsidiary. Dinallo regulates the insurance sub; he has no jurisdiction over the holding company. What’s more—and I’m sure Whitney understands this, as well--Jay Brown and the other members of MBIA’s board of directors have a fiduciary obligation to their shareholders. It is very, very simple.
If the rating agencies don’t rate MBIA’s insurance sub AAA, then the insurance subsidiary (which was overcapitalized even when it was rated triple-A, recall) is extremely overcapitalized at its new rating. The last thing the board should be thinking about, therefore, is sending the unit another $900 million. Especially since, with the company writing little new business, its risk exposure is declining.
Don’t forget, MBIA already exceeded S&P’s stated minimum capital requirements for a triple-A rating by $900 million at the end of the first quarter, and exceeded Moody’s minimum by $2.8 billion.
Despite what vocal shorts like Whitney Tilson have to say, neither MBIA or Ambac have capital or liquidity shortfalls. Interestingly, in eviscerating Jay Brown’s letter to his shareholders this week, Whitney let the following comment stand: “we continue to feel comfortable with our economic loss estimates embodied in the reserve and impairment figures we provided to the market in our last earnings call.”
So the company is manifestly well-capitalized, and continues to be comfortable with its loss estimates.
Whitney, maybe, just maybe, the outlook for MBIA isn’t nearly as bleak as you insist. It might pay to take a harder look!