Frank Li

Are The Ratings Agencies Really Taking a 'Tough Stance' on Subprime Mortgage Debt?

William Ackman of Pershing Square Capital Management talked about exactly this at the Ira Sohn dinner in May. Here's an excerpt from notes on what he said. The notes were taken in real time, and may contain transcription errors:

<blockquote>
<strong>William Ackman - Pershing Square Capital Management</strong&...

...Ackman highlighted the current liquidity environment while going into detail about the creation of liquidity using the ABS &amp; CDO markets. He highlights the moral hazard created by the fact that all parties are paid upfront, whether it is a mortgage origination on the smallest scale or credit securitization on a large scale.

<ol>
<li>Lesser securitized paper is given higher ratings then the underlying, because of the way ratings agency’s under measure correlation. The have recently made some statements to the effect that they have under measured correlation.</li>...

<li>Highlights the $800 Billion of subprime mortgages due to reset, the 2H of 2007 will be the most active part of this process.</li>

<li>Ackman makes the analogy that the same financial engineering in the subprime market is being used in the LBO market.</li>

<li>Ackman’s assessment of the market is that in recent weeks the liquidity in the CMBS market is drying up. He point to the weakness of REIT equities.</li>

<li>Ratings agencies responsible for theoretically “overseeing” the s structured finance market get near ½ there revenues from structured finance.</li>

<li>Portfolios are marked to model and not to market.</li>

</ol>



<em>Ackman offers a way to play this theory:</em>

<strong>Short-AB... Ambac Financial</strong&g...

<ol>
<li>$18.7 Billion in Subprime exposure is equal to 284.4% of statutory capital.</li>

<li>Leverage is 80.8 to 1 (Face Value Bonds/Statutory Capital)</li>

</ol>




<strong>Short-MB... MBIA</strong>

<ul>
<li>Structured finance has grown from 14% of guarantees in 1996 to 32% of guarantees in 2006</li>

<li>Leverage is 94 to 1 (Face Value Bonds/Statutory Capital)- Makes this comparison to Citigroup which is leveraged at 12 to 1 (Risk Adj. Assets/ Tier 1 Capital)</li>

<li>MBI’s Credit exposure is $635 Billion based upon $6.8 Billion in capital in comparison to Citigroup where Credit exposure is $1,107 Billion based upon$127 Billion of capital.</li>

<li>MBI’s Reserves/ Credit exposure equals 3 basis points in comparison to 96 basis points for Citigroup.</li>

<li>Potential catalyst- FASB is in a comment period about a rule clarification which will force insurers to book revenues as risk exposure mitigates. Currently MBI books approximately 45% of revenue at time of sale.</li>

<li>Significant senior management turnover in the past year. CFO, Chairman of the Board, President of MBIA Insurance, Head of Global Structured Products.</li>

</ul>
</blockquote>