A number of readers wrote to ask what the heck I meant, in my rhapsodic reaction to MBIA’s (NYSE:MBI) second quarter earnings report, when I referred to MBIA’s “adjusted book value” of $39.63 per share.
Here’s a shortish answer: MBIA’s adjusted book value is its reported book value of $16.67 per share, with a number of items that aren’t part of the company’s book value yet, but almost certainly will be in the future, added back in order to provide a more appropriate, accurate starting point for determining the company’s intrinsic value. The add-backs include:
Cumlative mark-to-market losses on securites, less cumulative impairment ($19.78 per share). Before the cussed FAS 157 took effect, this wouldn’t likely be a big number. But it is. Every quarter, MBIA has to mark the value of its financial assets and liabilities—everything from fixed-income securities to derivatives contracts—to their market prices at the end of the quarter. From an economic standpoint, the logic of FAS 157 is iffy. In most cases, remember, MBIA intends to hold its financial investments to maturity; variation in their prices between now and then is irrelevant. But in the near-term, the financial markets have seized up, which means the value of many of the company’s securities (and liabilities) has fallen for reasons unrelated to their intrinsic credit quality or fundamental outlook. As the markets eventually recover, MBI will reverse the negative marks and record net gains. In the meantime, it makes sense to add back the marks the company has taken (net of any cumulative impairments booked) to reflect the fact that the company is a long-term holder, and won’t actually realize the “losses” it says it has taken.
Deferred premium revenue ($6.06). This is what its sounds like. I’ll spare you the intricacies of insurance accounting, but remember that a cardinal principal of accounting is that revenues and expenses should be recognized in the period they’re incurred. In insurance, that’s not always so easy. When MBIA insures a municipal bond, for instance, it receives a single, lump-sum payment at the time of the bond’s issuance in return for credit protection that will last over the life of the bond, which could be 30 years or more. So MBIA doesn’t recognize all that cash payment as revenue all at once. Rather, most of it goes into a liability account called Deferred Premium. The company then recognizes the revenue gradually, over the life of the bond. The point here is that MBIA already has the cash premiums in hand. The only thing preventing those premiums from being revenue (and contributing to earnings) is the passage of time.
Present value of installment premium ($6.97). By the terms of most of MBIA’s CDO guarantees, the insured funds coverage via annual premium payments that will last over the life of the security—which can last decades. In virtually every case, these agreements are not cancellable by the insured. The present value of the installment premium is simply net present value of the premiums the company knows it will receive over the coming 30 or so years.
Asset/liability product adjustment ($6.18) In its asset management business, MBIA has sold guaranteed investment contracts to clients that promise a certain return over a certain period of time. In order to assure its GIC buyers that it will actually be around to satisfy the contracts it has written, MBIA has posted collateral with the buyers. That collateral will revert to MBIA once it makes good on its GICs.
Again, by current accounting rules, none of this counts in MBIA’s shareholders equity now, but will eventually. Tally it all up and add it to current stated book of $16.67, and you get to $39.63, by MBIA’s calculation. The question, then, becomes what multiple to book value should MBIA’s stock trade at? But with the stock trading at just 28% of adjusted book value now, that’s a discussion we can have another day.
Tom Brown is head of Bankstocks.com
Disclosure: The author manages funds that are long MBI and ABK