On the Monolines: Brown vs. Tilson, Round 2

The gloves are off now concerning my friend Whitney Tilson and his misguided analysis of MBIA (MBI). In his response to my criticism, he makes three claims that demand a response.   

1. MBIA’s management has an ironclad obligation to downstream $900 million in recently raised capital to its insurance subsidiary. Er, no, it does not. Whitney is in a tizzy because the company indicated when it raised the capital in January that it would downstream it to its insurance sub. He even says:

...investors, especially those who purchased the [surplus] notes [issued January 16, 2008] in the open market after May 12^th, might have quite a lawsuit against the company--and that the S.E.C. and N.Y. State Attorney General Cuomo might have an interesting investigation here.

Oh, please. I’ll get to the timeline of MBIA’s recent capital-raising saga in a moment, to put all this in some perspective. Before I do, though, remember that the following statement appears on every one of MBIA’s press releases—and similar language appears in the press releases put out by every other public company, for that matter [Emphasis added].

This release contains statements about future results that may constitute ‘forward-looking statements’ within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  Readers are cautioned that these statements are not guarantees of future performance.  There are a variety of factors, many of which are beyond MBIA’s control, which affect the operations, performance, business strategy and results and could cause its actual results of differ materially from the expectations and objectives in any forward-looking statements.  Accordingly, readers are cautioned not to place undue reliance on forward-looking statements which speak only as of the date they are made.  MBIA does not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements are made. 

Those words have meaning. Congress passed the Private Securities Litigation Reform Act, which gives management a safe harbor via the disclosure above, so managements can be open with investors about their plans and expectations about the future and not have to worry that they’ll be sued by shareholders whenever circumstances change, and actual events turn out differently from earlier predictions. This was an investor-friendly piece of legislation that enabled managements to talk relatively freely about the future as they saw it.

And now here’s Whitney, his knickers in a knot, insisting MBIA be “investigated” because management once said it “intended” or had “decided” to downstream $900 million of capital from the holding company to its insurance subsidiary, and then subsequently did not. Huh? Whitney plainly knows (he must know, right?) that managements who take advantage of the safe harbor have broad latitude to make decisions that are different than their prior stated intention.

What’s more, as you’ll see in a minute, the circumstance surrounding MBIA have changed drastically over the past several months, to the point that the company has an extremely compelling reason to not downstream the cash now. To see why, let’s look at the capital-raising hoops the company has had to jump through recently—and how those efforts fell flat in the end with the rating agencies: 

December 10, 2007. MBIA announces that Warburg Pincus has committed to invest $500 million in common equity, and to backstop a $500 million rights offering to the company’s existing shareholders.

January 9, 2008. MBIA announces a $1 billion surplus notes offering out of its insurance subsidiary, as part of a broader capital plan.

January 11, 2008. MBIA announces the pricing of the surplus notes offering.

This is the surplus-note sale that has got Whitney so exercised. He charges MBIA misled the buyers because the offering document said that:

...most of the net proceeds of the Warburg Pincus investment are expected [my emphasis] to be contributed to MBIA.

He then adds:

MBIA’s numerous emphatic assurances on this point were critical to getting the surplus notes offering completed, as we think few investors would have bought the surplus notes without the belief that most of the new money to be raised would be downstreamed to the insurance subsidiary junior to the surplus notes.

Come on. It wasn’t MBIA’s “emphatic assurances” regarding the proceeds that got the transaction done. It was the yield. Do you remember the surplus-note deal? Over the 30 days prior to the notes’ pricing, MBIA’s stock fell to $14 from $31. The notes themselves were priced to yield 14% through January 15, 2013, and then Libor plus 11.26% thereafter--even though the insurance subsidiary was rated triple-A! The buyers of this paper were not babes in the woods, therefore. They understood that this was not a typical AAA debt sale and knew, too, that the situation was volatile and circumstances might change.  If Whitney thinks MBIA misled investors during the offering and should now be investigated by the New York A.G., he’s either being disingenuous or is hopelessly naïve.

Anyway, back to the time line: 

January 18, 2008. Moody’s announces it is reviewing MBIA’s ratings for a possible downgrade.  Recall that the company had raised a total of $2 billion over the past month or so, and that on December 14—just 35 days before—Moody’s had said that if the company “ re-established a robust capital position, Moody’s would expect to revise the outlook to stable.”

Never mind. Moody’s at this point is too scared and confused to be thinking straight. Even though it had insisted on a huge capital raise just a month before, which MBIA then duly completed, now it was threatening to downgrade, anyway. (If anybody should be sued as a result of this sorry spectacle, by the way, it’s the rating agencies. But that’s another story.)

January 30, 2008. MBIA announces that it has completed the sale of $500 million in common stock to Warburg Pincus at $31 per share (versus a then-market price of the stock of $12). 

February 6, 2008. MBIA announces it will issue 50.3 million shares of common stock in a registered stock offering to raise $750 million.

(Say, where was Whitney following this announcement?  Previously the company had previously said, committed, planned, intended, and forecast that it would raise $500 million in a rights offering--but now it was offering $750 million in a straight secondary. Somebody call the cops! Management and the Board changed their minds!)

February 13, 2008. MBIA announces it has raised $1.1 billion from the sale of 94.6 million shares of common at $12.15. 

So a $500 million rights offering becomes a $750 million secondary, which turns into a $1.1 billion secondary. Should the company be investigated because it originally said one thing and ended up doing something else? Of course not. This sort of thing happens all the time and is a customary part of the capital-raising process. Yet it is exactly the type of thing that Whitney is clamoring that the A.G. and insurance commissioner investigate. Nutty.

In the end, some investors were happy the company raised $1.1 billion rather than $500 million, and some were not. But none have a legal remedy if they were disappointed. 

February 26, 2008. Moody’s joins S&P in affirming the triple-A rating of MBIA’s insurance subsidiary.

Both rating agencies did so knowing that the holding company was going to retain $900 million of the capital raised.  The rating agencies were not lied to, deceived, or tricked in anyway to suggest so it’s factually inaccurate.  

May 12, 2008. MBIA announces its first quarter earnings results, and says it plans to downstream $900 million in capital to its insurance subsidiary in the next ten to 30 days to strengthen the capital of the subsidiary, in an effort to maintain the unit’s triple-A rating.

Whitney claims this news came as a surprise, and that everyone had assumed the downstreaming had not already taken place. That’s simply not so.  New York insurance commissioner Eric Dinallo, for one, told the New York Times the next day that:

I was a fan [emphasis added] of the optionality of keeping the money at the holding company, as MBIA could then have started a new subsidiary for municipal bonds, or had other options.

So, clearly, MBIA’s chief insurance regulator was not distressed by MBIA’s action; in fact, he was a “fan” of keeping the capital at the holding-company level.

June 4, 2008. Moody’s places MBIA’s holding company and insurance subsidiary on review for possible downgrade.  Notably it does not mention capital adequacy as a factor in the announcement. 

June 5, 2008. S&P downgrades MBIA to double-A. Again, it does not mention capital adequacy as a factor in the downgrade.

June 11, 2008. MBIA announces it will not downstream $900 million in capital to the insurance subsidiary. 

So here we are, $2 billion in new capital later, all of which was raised so MBIA’s insurance sub could hold on to its triple-A, and the unit gets downgraded, anyway. Put the whole chain of events together, and it’s obvious that a lot has changed at MBIA between mid-December and today. Given that neither Moody’s nor S&P indicated that they had changed their capital models, or that MBIA’s insurance subsidiary was insufficiently capitalized, it made no sense for the company to proceed with its plan to downstream additional capital. According to Moody’s and S&P’s own models, MBIA’s insurance subsidiary is overcapitalized for a triple-A. It’s even more overcapitalized for its present double-A rating.

And Whitney believes the unit needs even more capital? There’s only one reason he can believe that, and it has nothing to do with any concern he says he has for the company’s policyholders. He wants to starve the holding company of cash, in order to help his short position. I have no problem with people talking their books—I’m doing so myself, at this very moment—but, please, spare me the outrage. 

As noted, Whitney makes two other claims in his response to me that are nonsense, as well.

2. MBIA’s insurance subsidiary doesn’t have sufficient capital or claims-paying ability. Whitney and the other shorts keep saying this, and I don’t understand why. Here are the facts:  MBIA’s estimate of the net present value of its future losses and impairment, for which it has reserved, is $2 billion. The rating agencies estimate losses will be $6-7 billion. But the company’s actual claims-paying ability—not what it’s reserved for, but the amount it could pay even if losses soar far beyond its expectations--is $16 billion. That is not a typo: $16 billion! There is simply no dispute on this point. Might losses rise that high? I suppose so, although I severely doubt it. If they do, though, you don’t just want to not own MBIA, you don’t want to own anything that even looks like a stock. Even Bill Ackman’s estimate of MBIA’s eventual losses, on a net present value basis, is several billion dollars less then the company’s claims-paying ability.

3. The New York State Insurance Commissioner has unlimited powers. Whitney seems to have gotten it into his head that Eric Dinallo can force the holding company to do whatever he commands, like, say downstream capital to the insurance subsidiary. Only he can’t. Insurance is heavily regulated, and the basis of that regulation consists of narrowly defined statutes. And in fact, MBIA exceeds the minimum capital required, as defined by New York statute, by several billion dollars. The commissioner might want the subsidiary to have more capital (that’s far from clear), but New York State law gives him zero authority to compel MBIA to move capital from the holding company to the insurance sub. 

Still, Whitney says:

Now that we know the insurance sub was not, in fact, overcapitalized [when MBIA upstreamed $1 billion from the insurance sub to the holding company in 2006 and 2007], why can’t Dinallo ask MBIA to give that $1 billion back?

Whitney, hello! To repeat the insurance sub already has excess capital as defined by New York statute!  If it were undercapitalized, as Whitney insists it is, the commissioner wouldn’t just ask for a downstreaming of capital, he would have the power to threaten to put the subsidiary into “rehabilitation” if no capital were forthcoming. But he hasn’t done that. The insurance sub is not undercapitalized, no matter how many times Whitney and his pals say that it is. 

Whitney Tilson and the others who are short MBIA consistently confuse the capital and liquidity of the insurance subsidiary of MBIA with that of the holding company. They also somehow seem to think that the company’s inability to maintain a triple-A at the insurance company must lead inexorably to the company’s solvency.  It won’t. MBIA’s estimate of the net present value of the losses and impairments in its insured book of business is $2 billion.

By contrast, the unit has claims-paying capability of $16 billion.  Those are the key numbers to watch going forward.  MBIA has plenty of liquidity at the holding company and insurance subsidiary.  The only numbers that matter are the company’s economic losses versus its ability to pay them.  With the stock at less then 20% of its adjusted book value, I like the risk-vs.-reward of owning MBIA. Having listened to Whitney’s objections, in fact, I like the risk-vs.-reward more than ever.

Tom Brown is head of BankStocks.com.

Comments

[apppro]

All of your comments are seemingly accurate. However, it’s really all meaningless as long as the forces that want to destroy the few monolines left for their own narcissistic reasons, exceeds the masses that need & want the monolines to prosper.
Even Rep. Barney Frank is now screaming that:
No new schools are getting built!
No new roads are being built!
Roads and bridges cannot be repaired!
Firehouses are in a state of disrepair!
Etc, etc, etc,………….

What have these short sellers created for us? I didn’t ask them to be my guardian angel and to look out for my financial well being. Did you?

E. Dinallo did a great disservice to us all. Instead of attacking and stopping the powers that were out there destroying everything, he forced down the throats policies and dilutions that only hastened the end of the monolines. No one has yet questioned the conflict of interest between, Buffet’s S&P affiliation and his new monoline.

The biggest issue not being considered is the circular downgrading of MBIA & ABK by using parameters that no one considered just a few months ago. Ratings downgrades warnings begets less business >> less business gets downgrades >> downgrades then beget less business >> which in turn begets more downgrades >> and so on and so on and so on!

[crashof2008]

This is one of the most inaccurate and distorted pieces of "journalism" i have ever read. It is a hodgepodge of confusion and dissembling.

The safe harbour language which he cites are about public statements offered in the connection with trading of registered securities. Nothing more, nothing less.

But to use this safe harbour language to defend MBI's completely unacceptable betrayal of its pledges to the ratings agencies is pathetic.

Earlier this year, MBI was intent on keeping its AAA rating. During the negotiations with the ratings agencies, Spitzer and Dinallo, MBI pledged that they would deploy the proceeds of various securities to be offered as a buffer to risky assets in various subsidiaries.

In exchange for this pledge, promise and commitment, all the other parties in the negotiation agreed to keep MBI's AAA rating intact on a provisional basis, pending periodic review required by the continuing collapse in key sectors of the derivatives market, including the term option bond sector used in short term muni financing, of which MBI is a market maker.

Simply stated, MBI broke that pledge they made during the negotiations. Now the ratings agencies are furious. They have been betrayed.

And to claim that somehow safe harbour language routinely issued in the issuance of securities issuance excuses their betrayal of the firm commitments they made to a number of key regulatory and quasi-public actors during critical negotiations is simply absurd.

Who are you trying to kid?

And the gibberish in this article goes on. I'll elaborate more fully shortly.

Matt

[apppro]

Of all the self-serving and self-promoting statements in your reply, this one takes the cake: "Now the ratings agencies are furious. They have been betrayed."
"Cry for me Argentina"
You've got to be kidding on this! Poor little ratings agencies. They sold the monolines a bunch of triple AAA rated garbage so they could collect their fees (now they get those fess anyway -more bs), and NOW they're cya'ing themselves big time by downgrading the very entities they promoted.

[mookie1]

I would take Thomas Brown’s opinion with a HUGE grain of salt as dont forget what his largest holding going into 2007:

1. New Century - filed bankruptcy
2. Accredited Lending - filed bankruptcy
3. First Marblehead - down 90ish%
4. CompuCredit - down big time and under investigation
5. Montpelier Re

among many, many, many other subprime and subprime related companies.

Here is a quote of his 11/30/07 about First Marblehead:

Speaking at the annual Value Investing Congress in New York City, Tom Brown of Second Curve Capital, is pitching First Marblehead (NYSE: FMD) at the Value Investing Congress in New York. He says “First Marblehead is a 20% grower, has a PE 6, P/E/G of 0.2 and should be a three bagger in two years.”

At the time FMD was $50ish..today at $4.40

I would say his opinion is worth much!!!!!!!!!!!!!!!!!

[oldlures1]

Excellent job, Mr. Brown! Well-articulated and, dare I say, ironclad! <grin>

[oldlures1]

Sadly thought, it also reminds me of my suspicion that MBI and ABK (and possibly FSA next?) are casualties of a well-orchestrated, collaberative effort by parties (such as the hedgies, Buffett and the rating agencies) to destroy the companies and create opportunities for profit in the process. Admittedly, I believe this has been a commonly employed tact for decades. However, it one thing to impact a company, its quite another when those actions impact $1 trillion in debt and the entire financial system! I've got to believe that much of the current turmoil will dissipate once the election is over.

Good grief, what have I become?! I've never EVER been conspiracy-minded, but when left with no reasonable (factual) substantive evidence for events, I guess I have search for explanations elsewhere.

[crashof2008]

Brown didn't just betray the rating agencies. He betrayed the people of New York and the the insurance commissioner with his lies and his betrayal and false promises.

It's payback time now. If he thinks that he can spin off a AAA unit and provide huge bonuses in the process for him and his henchmen, he is seriously, seriously mistaken.

[sulli5]

Great post Mr. Brown. Tilson does not get it and it is very simple. Moody's and S&P said that MBIA needed more capital to keep it's AAA. MBIA got more capital to maintain the AAA. They deluded the stock to do it but they felt it was worth it. After the capital raise, both rating agencies reconfirmed the AAA rating. MBIA was playing by the Agencies rules. With the addition capital and the money from runoff MBIA met all requirements for the AAA. The rating agencies are running scared because of their poor record in recent times. They decided to throw MBIA overboard because they feared bad publicity. MBIA raised the money for one purpose and that was to maintain the AAA. When the rating agencies changes the criteria that purpose also changed. MBIA does not need more capital so why should they put up the money when it is not needed but use it for other purposes like buying back stock. Moody's penalized MBIA for holding back the money and in their recent communication indicated that they would not give MBIA new insurer a AAA. It's the rating agencies who should be downgraded which they have been in the court of public opinion

[oldlures1]

sulli5 - you're right on target! On certain fronts of the evolving soap opera boiled down to little more than a pissing contest. However, on a larger scale, the rating agencies have acted quite irresponsibly, wield an extremely powerful tool with unprofessional abandone. In fact, I liken their behavior of late to that of 3-yr old wielding a samarai sword in the midst of temper tantrum...and MBI and ABK are trying desperately to withstand the undeserving blows. Aside from my personal investments, I truly hope the companies survive, as they don't deserve what's been handed to them; they truly don't.

crashof2008 - I'm sorry to say, but it would appear that you've long since succomb to the magical flute of the pied pipers (Ackman, Tilson and the like). Good luck.

[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. This coming back will be the best advertisement to recruit new clients.

[Ishortyou]

Monolines are getting or extending line of credits to clear up doubts of solvency or book value.

[howling wolf]

Throughout these comments there is little or no mention of two add'l facts:

(1) Barrons is sticking to their recommendation to Buy in a follow-up story, believing there claims paying abilities far exceeds expected losses

(2) Is MBIA most likely in Run-off? If so, how do these analyses change?

[fxtrader07]

@crashof2008: you wish for a crash, you wish for mbi/ABK to go bk. Well, your choice. I doubt though, that you ave even the slightest grasp of the wider implications and of the situation required to make that happen. As Tom brown put it very well: 'you don't want to own anything that looks like a stock then'
It is one thing to be prudent and to prtect one's wealth against a crash. It#s entirely another to position in such a way as to heavily profit from a crash. it changes perspectives on a wide array of issues. For instance, you will now be searching the news for every bad headline theire is. You must hope now that the sky starts falling. That mopre people lose their jobs, that real estate crashes further, that oil rises even faster, that municipalities go bk etc. What a miserable approach to life! To eagerly wait for bad news and to get pretty much uneasy when good news trigger in instead.
Think about it - is it worth that?

[Value Dope]

Good post, although go easy on Whitney, he's just talking Ackman's book that he steals and charges 2/20 for. What's that Bill, you're short MBI and ABK, ok I need to do that too. What's that Bill, you're long TGT, ok me too. Just tell me what to say so my investors think I know something about these positions! What's that Bill, you're in BKS and BGP, so is T2!!!

Too bad for Tom Brown though, now he won't be at any of Whitney's Value Congresses lol. I think Tilson makes more off those conventions and his newsletters than he does actually managing money! He's good a great scam going, like Pabrai, talk the Buffett game all the time but be anything but. PNCL = Dhando!!