Despite Warburg Pincus' Investment, MBIA Needs More Capital Infusion

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Includes: AMBC, MBI, RDN, UBS
by: Accrued Interest

What did we learn today? As you probably know by now, Warburg Pincus has agreed to invest $500 million in MBIA (NYSE:MBI) stock (about 13% of the company), as well as backstop a $500 million shareholder rights offering which MBIA plans for Q1 2008. In exchange for backing the future offering, Warburg is getting $500 million in warrants priced at $40/share. I'd think that if Warburg is willing to invest at $31/share, there won't be trouble getting the public to take another $500 million.

Perhaps more importantly, UBS (NYSE:UBS) is getting a $10 billion infusion, mostly from the government of Singapore and an unidentified Middle Eastern investor.

So what does that tell us? Mainly that there is capital still out there, and, at the right price, some one think banks and/or monolines are a worthy investment. But we kind of knew that already, this really just confirms it. We've seen Countrywide (CFC), Citigroup (NYSE:C), E*Trade (NASDAQ:ETFC), and CIFG recently get large cash infusions. So there is capital out there, willing to buy into subprime-tainted companies at the right price.

What else did we learn? Both MBIA and UBS announced they expected to take large losses. MBIA said it would set aside up to $800 million to cover losses, and that the "fair value" of its portfolio has declined by $850 billion in the 4th quarter. UBS said it was taking a $10 billion write down and warned that it may record a loss for all of 2007. Note that in both cases the losses being recorded are about equal to the equity infusion. So we've learned that both companies are merely replacing capital they've lost.

Now some commentators are already dismissing MBIA's new capital for this very reason. Beware the simplistic analyst! We knew MBIA had losses to take; that's exactly why they needed more capital. So you can't say the capital infusion is inadequate for the sole reason that MBIA announced losses. In fact, if I'm MBIA, today is the perfect day to increase my loss reserve, since the market will be focused on all the good news anyway.

However, my view is that this won't be the end of MBIA's need for more capital. MBIA has about $84 billion in residential ABS and "multi-sector" CDOs, vs. about $82 billion with AMBAC (ABK). I recently estimated that AMBAC would need $2-3 billion in new capital, so I'd suspect that before this is all said and done, MBIA comes back to the market for more. Note I didn't say that MBIA would get downgraded. I have a strong suspicion that the bond insurers have been tipped off by Moody's and Fitch as to how the capital adequacy studies are going. I further suspect that any capital improvements you hear about in the coming days are over and above what Moody's and Fitch will announce (supposedly next week) is needed.

The best case scenario for the bond insurers is that they get new capital now, and are able keep adding capital through run-off, writing new municipal policies, smaller hybrid/preferred offerings, etc. As long as these increases in capital keep up with any losses they take, the ratings agencies never threaten a downgrade again. More importantly, the investing public still values bond insurance as a concept, since we'll all view the current episode as proving the insurer's strength, rather than a failure of risk management. I view this as unlikely.

The worst case scenario is that all or most of them raise new capital now (which is inevitable), but investors downgrade the value of bond insurance generally. It's possible this will cause the bond insurers' book to dwindle to nothing, but I doubt it. What's more likely is that bond insurance will change from being written to "zero loss" as it is now, to being written mostly on riskier municipal credits. In other words, MBIA's business model moves closer to that of Radian (NYSE:RDN). MBIA charges more for its insurance, but writes a lot fewer policies. Whether all the current players in bond insurance can survive in such a world has yet to be seen.

Disclosure: No position in any company mentioned, although author owns many insured municipal bonds.