MBIA: Moody's Twists the Knife

Ouch! This news is really bad for MBIA: Moody's has slashed its ratings by even more than it cut the ratings on Ambac. It's a deep cut, with real financial consequences:

This ratings action will give certain holders of guaranteed investment contracts the right to terminate the contracts or to require that additional collateral be posted

The main rating, of MBIA Insurance Corporation, the insurance subsidiary, has fallen all the way to A2 from Aaa. That's a five-notch downgrade, which I think I'm safe in saying is more severe than anybody expected.

And there's more:

Moody's also downgraded the surplus note rating of MBIA Insurance Corporation to Baa1, from Aa2, and the senior debt rating of the holding company, MBIA, Inc. (NYSE: MBI) to Baa2, from Aa3.

Yes, those are Bs. Investment-grade Bs, to be sure, but Bs all the same. Both of these constitute six-notch downgrades: obviously keeping newly-raised equity at the holding company level didn't help its ratings at all.

These downgrades severely impair MBIA's ability to continue as a going concern. Until now, I've been focused on MBIA's solvency: most crudely, whether or not its assets exceed its liabilities. (They do.) But CEO Jay Brown doesn't just want a solvent company: he wants a company with a future. And it's hard to see where that future lies if the holdco is barely holding on to an investment-grade credit rating. The whole point of insurance companies is that they're ultrasafe: as soon as that safety is called into question, no one wants to do business with them any more.

Until this morning, I thought MBIA's plan to create a new triple-A subsidiary had some hope to it. But now that seems pretty improbable. As Moody's says, in something of a self-fulfilling prophecy, "today's rating action... reflects MBIA's... impaired franchise".

So, MBIA still has money. As Moody's also says:

the group remains strongly capitalized, estimated to be consistent with a Aa level rating, and benefits from substantial embedded earnings in its existing insurance portfolio.

In numbers:

Moody's has re-estimated expected and stress loss projections on MBIA's insured portfolio, focusing on the company's mortgage-related exposures as well as other sectors of the portfolio potentially vulnerable to deterioration in the current environment. Based on Moody's revised assessment of the risks in MBIA's portfolio, estimated stress-case losses would approximate $13.6 billion at the Aaa threshold and $9.4 billion at the A2 threshold. This compares to Moody's estimate of MBIA's claims paying resources of approximately $15.1 billion... Relative to Moody's 1.3x "target" level for capital adequacy, MBIA is currently $2.6 billion below the Aaa target level and is $2.8 billion above the A2 target level.

But money alone might not be enough. Especially since Moody's is leaving the door open to further downgrades:

The outlook for the ratings is negative, reflecting the material uncertainty about the firm's strategy and the non-negligible likelihood of further adverse developments in its insurance portfolios or operations.

At this point, the best-case scenario for MBIA is that credit markets calm down enough for the company to be acquired by someone with credibly deep pockets. (Sounds a bit like Lehman Brothers.) Absent that scenario, which admittedly is pretty improbable, things are likely to be pretty precarious at MBIA for the foreseeable future.

Comments

[Ishortyou:]

In respect to AMBAC and MBIA, they need to keep and save all the cash possible including stop paying dividends, deleverage from all their risky liabilities specially those CDS, CDO's, RMBS-ABS of uncertain value, in order to remediate their book values, once their book values are sound they need to reinstate their triple A rating again to write new low risk public bond insurance business.

They are already doing these, so it will take some time to deleverage their books from uncertainties and rewrite new business again.

2008 Jun 20 11:08 AM

[The Jackal:]

There is no financial engineering that will save MBI or ABK......they are COOKED.....both ZEROs within a couple of months.

2008 Jun 20 11:23 AM

[User 148443:]

I'm a farily new investor, but can someone tell me why ABK and MBI are going to stay in business? Cash is great, but who is going to come to them with new business? Even if they split the company to focus on structured products and munis separately why would someone get insurance from a company that can't manage its risk? Furthermore, it sounds like their is going to be new competition in the muni market.

2008 Jun 20 12:07 PM

[Ishortyou:]

for AMBAC and MBIA there is only one choice: deleveraging the books from risky uncertain liabilities to upgrade their books and ratings, no a brainer really. Competition is healthy in any market.

2008 Jun 20 12:17 PM

[oldlures1:]

User148443 - welcome to the party! You're coming into this game at an interesting juncture. Personally, I'm heavily vested in MBI, so I'm going to ride this pony 'til it bucks me off. That said, I'd be remiss if I didn't advise you to wait on the sidelines. My confidence is getting rattled these days, not because I doubt the companies' numbers, but because there are forces at work here that are less obvious and very unpredictable. The companies' financial fundamentals are sound; they exceed the rating agencies capital requirements and can pay policyholders under worst-case scenarios. So why are they being downgraded, you ask? Good question. Frankly, they shouldn't be. But this all has evolved into a classic example of (false) perception becoming reality.

It all began when activist hedge fund managers, like Ackman, shorted the monolines. They then intentionally launched highly visible, well-executed propaganda campaigns to trash the companies. Like the rats led by the Pied Piper of Hamlin, the market soon began to buy into the propoganda. Ackman and other were successful in creating a "perception" (albeit a false one) that began to manifest itself into a "reality". The stock price dropped, and Ackman (and fellow manipulators) made a bundle on their short positions. As expected, the companies' reputations fell under fire, and they soon found it hard (although not impossible) to write new business. Yes, they were still writing business, but much less than before. The rating agencies, which had maintained the companies' AAA-ratings, soon fell under scrutiny from the market place. The mkt couldn't understand why its "reality" wasn't that of the rating agencies, as such it deduced the rating agencies were inept. Feeling the pressure, the rating agencies downgraded the monolines, but lacked substantive supporting evidence, so they quoted such things as "financial flexibility" and "franchise value" as reasons for their actions. In other words, they questioned the monolines ability to write new biz. But remember, they were, in fact, still writing business...albeit much less. Given enough time, the Pied Piper-induced "reality" would have, in time, dissipated like an oceanic fog on a sunny day, and the monolines could have henceforth resumed business-as-usual. However, by downgrading the monolines, the rating agencies effectively shut the monolines' doors; they can't write biz without the "AAA". Ironic, isn't it? And so now you find MBI and ABK trying to open new entities via pre-existing subsidiaries. The subsidiaries can be rated "AAA"; they don't need the holding co's rating.

Sure, you'll hear a lot of rhetoric about how monolines are toast. But ask yourself this, if that were the case; if the whole industry was doomed, why did Buffett just enter the market via his newly created monoline, Berkshire Hathaway Assurance (who, by the way, owns 20% of Moodys rating service -- interesting huh?).

Meanwhile, Ackman and is others activist hedgies keep blowing away on their magical flutes, and the market rats follow mindlessly. Ackman is now "out" of his positions on MBI and ABK, so he's trained his sight on FSA, a AAA-rated (for now!) monoline.

I truly hope MBI and ABK survive this. Sure, they made mistakes, and should take their blows accordingly. But their mistakes are not (and should not be) dibilitating. They're good companies, with sound fundamentals and strong leadership, that should be allowed to survive on their own merits and not be destroyed by the selfless, self-centered antics of activist hedge funds.

2008 Jun 20 02:49 PM

[phantomfive...:]

Berkshire entered the market precisely because of the opportunity created by the stupidity of the monolines themselves. There may indeed be a future in the bond insurance business, but not for anyone who is currently on the hook for multibillions in CDS's on toxic MBS. That pretty much disqualifies MBI and ABK. Sorry, but Ackman has been right all along. It's all over but the shouting, which is beginning now.

2008 Jun 20 04:21 PM

[oldlures1:]

phantom - I'll offer that Ackman has not been "right" with regard to the monolines specifically, but rather he's only been "right" in predicting the effectiveness of his propaganda and it's ability to manipulate the market. His propaganda has created an environment (and perception) adverse to the monolines, leading them to where they are today -- not on fundamentals, but perception. In fact, I'll offer that none of his predictions with specific regard to performance of their respective portfolios has materialized. But that irrelevant, as he has still managed to gain from the companies' distress. Yes, I'll concede, his "predictions" are becoming "reality", but it little to do with the monolines and almost everything to do with creating false perception and lack of confidence in the market. Marty Whitman called Ackman a "slick salesman", and "slick" he is! I prefer to compare him to the Pied Piper; he plays his magical flute for the masses and they follow his lead - i.e. whatever he says, it must be right! And unfortunately, that is exactly how this has played out. The mkt has yet to wake from its trance to realize how sinister a customer he is! He's a reckless, self-centered, dare I say dangerous, individual.

2008 Jun 20 05:30 PM

[User 148443:]

Hmm.....I see your point oldlures1, but regarldless of how it happened do you see MBI and ABK surviving?

2008 Jun 20 05:39 PM

[The Jackal:]

The Moody's downgrade alone will force them to make $7.4 billion in payments. According to Bloomberg "MBIA has $15.2 billion of assets available to satisfy the requirements, the company said yesterday in a statement. That includes $4 billion in cash and short-term investments, $1 billion of unpledged collateral and $10.2 billion of other securities, MBIA said." I bet that the $10.2 billion of "other securities" are MBS or CDO or other crap that they are marking to model not to market. I am sure the $10.2 billion is more like $5 billion when it's mark to market. The $7.4 billion payment is just the beginning, there are still going to be other losses they have to cover that arent related to the the payments triggered by the Moody's downgrade. No new business coming in. THEY ARE DONE !!!!!!!!!!!!! MBI will down 50% on Monday.

2008 Jun 21 11:01 AM

[ussmls7:]

Goldmans,dump all of Wothless SIV's upon the World,knowing they where & will remain Worthless,If all those that jump in to try to make more money from these Worthless SIV's,had ask why was Goldmans unloading them,then shorting them,where would BS,& the others that are writeing down billions? With Goldmans close ties to the Feds every move,who is running the Fed? Why are Americans going to be the biggest losers? Because all the worthless paper the Fed brings in, while giving away our youths futures to I-Banks that are to big to fail!! Well they are failures, but untill it has been marked to market, & Congress gets out of the way, & let the markets purge the scum from all markets!

2008 Jun 21 11:30 AM

[mythoughts:]

MBI is done, period. There is too much AAA rated competition for them to survive. Sorry OLDLURES1. Do you really collect old fishing lures?

2008 Jun 21 02:21 PM

[richandstupid:]

Gulp! It is so hard to make horrible news sound ok.

2008 Jun 22 11:49 AM

[oldlures1:]

User148443 - I wish I could say definitely, but I just don't know. Admittedly, I was more confident months ago, but the unpredictable (if not irresponsible!) actions of the ratings agencies have shaken my otherwise fundamental approach to investing. I don't think MBI or ABK will be insolvent, which is what most adverse opinions insinuate, but how they go-forward is the question. Will it be in run-off, or will they continue under a different name (via resurrecting the biz in one of their subsidiaries, or after being acquired).

mythoughts - yes, I collect antique fishing tackle. And I must admit, at this juncture, it has proven to be a better investment than my various holdings in the financial sector.

2008 Jun 22 12:32 PM

[Bill Murray:]

Pls turn to page 33.

library.corporate-ir.n...

Thats $129 billion of CDO exposure. $129 billion. No one has booked this stuff to its true value so its difficult to tell what this stuff is really worth (and what these guys will have to pay out in insurance claims). Well, actually, JP Morgan put a $2 price tag on this stuff when they bought Bear Sterns ($150/sh company a few months earlier)? So if JP Morgan says $150 is now worth $2, wouldnt you have to say that $129 billion is now worth, 1.7 billion? Yikes.

2008 Jun 22 05:08 PM

[oldlures1:]

Bill - I understand your point, but it's not that simple; you can't compare MBI and/or ABK's utlimate CDO exposure to the "fire sale" market value of Bear - they have some comonalitities, but overall they're quite different valuations.

Also, be careful not to compare total CDO value, or lack thereof, with the exposure to loss by MBI and/or ABK. Neither company is exposed to the entire CDO, only the senior and super-senior tranches of CDOs. And should those senior or super-senior tranches be breached, MBI and ABK are only obligated to make semi-annual pmts of P&I on the debt, not a lump sum. Of course, all you hear about is the lump sum book-adjustments for market-to-market valuation discounts, which is a non-cash GAAP entry (i.e. in the real world, it means nothing.)

I'm not trying insinuate that neither company will take a hit on their CDO exposure; they will, but I don't believe it will come anywhere close to the dire predictions expounding by (or extrapolated from) the headlines of many "short" writers.

Just my two cents. And admittedly, that's about all it's worth.

2008 Jun 22 08:39 PM