Ackman's Proposal for Bond Insurers - Some Thoughts

Includes: AMBC, MBI
by: Whitney Tilson

Bill Ackman made public Wednesday his proposal to save the bond insurers. [Editor's note: It's embedded below.]

In short, Ackman proposes a twist on the good bank/bad bank proposal being discussed. Rather than both banks independently linked to the bond insurer holding company, he instead recommends the creation of a new subsidiary to the current insurance sub that would assume the existing muni bond business, presumably retain an AAA rating, and be able to write new business. The remaining business, responsible for the structured finance policies, could go into runoff and pay the structured finance claims. [See graphic on page 8/9 of below document.] the attached)

A portion of the capital of the current company would be used to capitalize the new company, with the remainder used to pay claims from the SF biz.

Contrary to the assertion of the NY insurance dept (see below), this is actually a great deal for the SF biz because it would retain ownership of the muni biz and should the muni biz have profits and/or go public someday, the SF biz would benefit. In other words, taking some of the bond insurer's assets today to capitalize the muni biz would not be averse to the interests of the SF claimants, as this money would be used to create a profitable and valuable muni biz, to the benefit of the SF biz.

This proposal, however, will be opposed (see MBIA's press release, below) by those with an interest in the public holding companies (management, shareholders and debtholders). They would prefer the good bank/bad bank model because it would allow profits from the muni business to flow directly to them, cutting out the claimants of the SF biz.

The only problem with this, as the editorial in today's WSJ makes clear, is that ALL policyholders of the bond insurers have a senior claim to ALL claimants at the holding company level. A plan that allows the holding company to profit from the muni biz while leaving the SF claimants in the lurch is wrong and illegal -- and would undoubtedly be subject to endless litigation.

1) Here's the WSJ editorial:

Mr. Dinallo has made the "consequences" crystal clear, blessing plans to split bond insurers in two: a highly rated company to take care of his colleagues in state and local government, and a lower-rated company to provide for the private market. Imagine buying a policy from a name-brand insurer. Then, when it appears you may file a claim, the insurer informs you that your policy has been transferred to Joe Bob's Insurance, with a lower credit rating and less ability to meet its obligations.

The editorial also asks a good question: "Does New York law mandate that Mr. Dinallo put the interests of government bond issuers above those of private issuers?" Ackman's plan addresses this fairly because the private issuers (i.e., SF claimants) will own the muni bond business and benefit from it.

2) I understand why the managements of the bond insurers don't like Ackman's plan, but I was puzzled this this statement:

``Our concern with the Ackman plan is that it would split the company and the structured side could be substantially downgraded which would be bad for the banks,'' said David Neustadt, a spokesman for the New York State Insurance Department. ``Our preference is a plan that keeps an AAA rating on everything.''

Of course NYSID (and pretty much everyone else) would prefer a plan that keeps an AAA rating on everything. I'd like world peace and apple pie for all -- but that's not gonna happen either. If Dinallo has a huge bailout up his sleave that will save the bond insurers, then let's see it. Otherwise, Ackman's plan is the best alternative. It requires no additional capital from anyone, keeps muni bonds protected and AAA rated, and offers the best hope to SF claimants. The only people who aren't benefitted are those who, by design, are last in line. If the managements of the bond insurers are right that the mark-to-market losses don't turn out to be real, then they too will benefit from this plan -- but only after policyholders are protected.

3) Here's MBIA's press release, with the usual attacks:

"Like Mr. Ackman's open source model, his statements in the media and the barrage of letters he has sent to regulators and the rating agencies -- which contain half truths, innuendo and faulty analysis -- this proposal is simply a continuation of Mr. Ackman's campaign to profit from his short positions and credit default swaps in the bond insurance industry," the company said.

Note how they cleverly try to link their interests to the banks, when in fact their interests are diametrically opposed:

MBIA said it agrees with the NYSID spokesman who said Mr. Ackman's proposal is not good for one group of policyholders. "Our preference, like the regulators, continues to be finding a solution that would be in the best interest of all policyholders," the company said.

Disclosure: Short MBIA