On the Monolines: Brown vs. Tilson, Round 2

Includes: AMBC, MBI
by: Tom Brown

The gloves are off now concerning my friend Whitney Tilson and his misguided analysis of MBIA (NYSE: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 12th, 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.