Wednesday, 13 May 2009 01:00

MBIA: A Low-Down Dirty Shame

This is an Op-Ed piece by BoomBustBlogger Mark. An interesting point of view and an example of the type of intellectual capital that roams theses pages of the BoomBust.

For those willing to look deeper than company press releases, publicly available information suggests that investors should avoid MBIA like a plague. As important as it is for investors to analyze MBIA's current economic position, however, the more important MBIA story lies in the lapses by those responsible for safeguarding policyholders of MBIA Insurance Corporation, MBIA's principal insurance subsidiary until February of this year when its assets were stripped. Parts 1 and 2 of this note discuss issues that should concern MBIA investors. Part 3 raises questions about what appear to be disturbing oversight failures.


Loss Reserves

Despite the large losses reported to date, MBIA's loss reserves appear to remain disconnected from economic reality and deficient by conservatively $5B, easily enough to wipe out MBIA Insurance Corporation's capital. Here are the main problem areas.

  1. Second lien securitizations - MBIA paid approximately $600M on second lien securitizations during the first quarter, 75% of the year-end net reserves for these exposures. Servicer reports reveal that delinquencies on these deals increased to $2B during the first quarter. Therefore, payments are likely to continue at similar pace through the end of 2009. MBIA's net reserves decreased to approximately $600M ($1.2B minus $600M in anticipated recoveries from servicer lawsuits) as of the end of the first quarter, an amount that could easily be exceeded next quarter. If loan performance does not improve, MBIA's future payments could exceed $8B. If loan performance improves gradually, investors should expect around $4B in future payments.
  2. Multi-sector high grade CDO impairments - Slide 44 of the first quarter earnings presentation ( illustrates cash flow projections for MBIA's high grade CDOs which imply about $3.2B of ultimate principal payments. By comparison, recent loan performance for the RMBS securities in MBIA's high grade CDOs suggests that losses will significantly exceed Pershing Square's Open Source Model projections from a year ago. Realized collateral losses in excess of subordination levels are likely to surpass MBIA's ~$3.2B estimate within the next six months, then grow to a low end ultimate estimate of approximately $6B, assuming steady improvements in loan performance. If loan performance does not improve or improves more gradually, ultimate principal losses could easily exceed $10B.
  3. Discount rates - The cash flows and present value impairment figure for high grade CDOs on slide 44 indicate that MBIA will consistently earn a significant spread above LIBOR, probably around 150 basis points, for the next 40+ years. The discount rate is discussed in MBIA's 2008 10-K, which suggests that the New York Insurance Department allowed MBIA to artificially inflate the rate by using a portfolio yield calculated excluding low-yielding money market investments and including intercompany loans under repurchase agreements. Discounting at LIBOR would more than double the present value impairment numbers.
  4. Guarantees of MBIA's investment management business - As of the end of the first quarter, the book value of liabilities of MBIA's investment management business exceeded the book value of assets by $500M. The market value shortfall was $2B. It is difficult to imagine how MBIA Insurance Corporation, which guarantees these obligations, can avoid a liability for the book value shortfall, at a minimum. MBIA Insurance Corporation's Statutory financials do not reveal any such a liability.
  5. Mezzanine CDOs - $500M is a reasonable estimate of losses on US and European mezzanine CDOs based on the ratings of the underlying collateral and subordination levels shown in MBIA's first quarter CDO disclosure. MBIA's public disclosures do not provide any indication that a liability has been established for these exposures.

Commercial Real Estate

If commercial mortgage performance deteriorates to the extent anticipated by CMBS pricing, MBIA will realize losses well in excess of $10B on structured CMBS pools and commercial real estate CDOs (based on MBIA's November 8, 2008 commercial real estate presentation). Loan losses large enough to wipe out CMBS securities originally rated BBB or lower from 2005 through 2007 would result in losses in the neighborhood of $5B. SEC filings state that MBIA would make payments once realized losses breach subordination levels for most structured CMBS pools, so it would be impossible to suppress these liabilities using steep discount rates. MBIA Insurance Corporation has established no reserves for structured CMBS pools and commercial real estate CDOs.


Originator Lawsuits

MBIA has filed lawsuits against originators responsible for about half of MBIA's known losses, Merrill Lynch, Countrywide, and Residential Funding. The Merrill lawsuit alleges Merrill deceived MBIA into assuming credit risk on four CDOs. The Countrywide and Residential Funding lawsuits allege that loans supporting second lien securitizations breached these originators' representations and warranties, and therefore need to be repurchased.

MBIA's complaint against Merrill argues that MBIA did not perform adequate due diligence and Merrill knew this. This lays a shaky foundation for a claim because most people believe that it is incumbent on large financial institutions to diligently review relevant information before assuming credit risk on large transactions. In addition, the complaint makes several allegations that are false or irrelevant. Here are a few examples.

  1. MBIA's lawsuit claims that Merrill exploited an advantage due to detailed analyses of loan level data that Merrill performed, but MBIA did not This contradicts MBIA's February 11, 2008 response to Pershing Square Capital's Open Source Model, where MBIA describes a "loan by loan analysis" much more detailed than Pershing Square's analysis. At the time of this letter, both MBIA and Pershing Square had access to much better and more current information than Merrill had at the time the deals were closed, yet MBIA was projecting no impairments on these deals.
  2. Page 27 of the complaint states that collateral losses had wiped out all or most of the subordination as of the closing date for each disputed CDO. This is obviously false, as it would have made it impossible for these deals to carry even spurious AAA ratings when they were closed. In addition, MBIA disclosures showed that subordination levels remained largely intact through year-end 2007.
  3. Subsequent to closing the deals with MBIA, Merrill reported losses on CDOs multiples larger than the losses hedged through MBIA. These losses nearly led to Merrill's collapse. If Merrill knew that these structures would generate massive losses, as the complaint alleges, other CDOs would have been sold or hedged in 2007.

Page 7 of the complaint argues that the disputed transactions threaten MBIA Insurance Corporation's ability to maintain minimum capital and solvency requirements. If these transactions threaten MBIA Insurance Corporation's solvency, how could management possibly justify the February restructuring that further weakened this capital position?

The Countrywide and Residential Funding lawsuits and MBIA's forensic analysis of loan files will almost definitely yield future recoveries in cases of very clear breaches. However, the prospectuses for these deals may make it difficult to obtain sweeping recoveries, because these documents clearly highlight their extraordinary credit risk, and in fact disclose many of the problems identified in the complaints as contributing to the claims for damages. In other words, the loans were bad, but they were clearly advertised as being bad. In addition, the Countrywide and Residential Funding deals have performed similarly to other second lien securitizations that MBIA wrapped, including CSFB, Morgan Stanley, and IndyMac deals. This will make it difficult to argue convincingly that these companies' underwriting was generally substandard.

A fundamental problem with MBIA's lawsuits against originators derives from MBIA's access to superior information and unique perspective to anticipate the mortgage crisis. Instead of withholding capital and voicing concerns about the erosion in credit quality, MBIA leveraged its balance sheet with credit risk. MBIA's lawsuits allege that MBIA was an unwitting victim, when in reality MBIA was part of the problem.


Complaints by Aurelius and Third Avenue seek to reverse or modify MBIA's February 2009 restructuring, which diverted over $5B away from MBIA Insurance Corporation to fund another subsidiary. These lawsuits mention that rating agencies slashed MBIA Insurance Corporation's ratings, and CDS pricing on MBIA Insurance Corporation obligations spiked to 70% up-front (which implies almost a 100% probability of default) immediately following the restructuring announcement. These two facts provide compelling evidence that the restructuring left MBIA with inadequate capital, a key ingredient in a constructive fraudulence claim.

However, plaintiffs' strongest ammunition in these lawsuits may have come from MBIA managers, who claimed that the restructuring would motivate insureds to terminate MBIA's obligations at a discount. This implies that there was intent to hinder creditors, a requirement in showing intentional fraudulent conveyance. These comments might also convince a court that MBIA breached its duty to negotiate fairly and in good faith, as the complaints allege.

The restructuring was designed to allow MBIA, which has effectively been in run-off for the past year, to write new public finance business. However, the uncertainty introduced by these lawsuits makes it unlikely for MBIA to generate significant new business for the foreseeable future. This leaves long-term investors with the likelihood that toxic legacy assets will wipe out shareholders' equity, without the upside that would come with new revenue generation.


A Low-Down Dirty Shame

The views expressed in this note are shared by a variety of investors. Therefore, if it distorts the truth, MBIA management or any other interested parties should seize the opportunity to disabuse the investing public of any misconceptions, and turn critics into advocates.

If the facts and conclusions are basically correct, the situation raises numerous questions for individuals charged with protecting policyholders' interests.

  1. How could the New York Insurance Department allow over $5B to be extracted from MBIA Insurance Corporation, leaving it at best drastically undercapitalized, and at worst insolvent? And why would regulators allow the restructuring to place the interests of policyholders below the interests of MBIA management and shareholders?
  2. Why have insurance regulators been so willing to facilitate transactions that transfer needed assets from insurance operations to other holding company operations? Examples include loans to investment management affiliates of monoline insurers, and an offer to allow AIG's insurance subsidiaries to assume credit risk on risky securities insured by the financial products division of AIG. These types of transfers clearly increase risks to policyholders, the group that insurance departments are charged with protecting.
  3. How have regulators and auditors allowed monolines to recognize large anticipated litigation recoveries given that the likelihood of such recoveries is highly questionable?
  4. How have insurance regulators justified the reduction or elimination of Statutory contingency reserves in the face of unprecedented credit risk?
  5. Why would the New York Insurance Department allow creative calculations to boost the rate used to discount MBIA's losses?
  6. What has prevented the National Association of Insurance Commissioners or other agencies from investigating or at least questioning the New York Insurance Department's decisions to repeatedly facilitate large transactions that place the interests of shareholders and management ahead of monoline policyholders? In addition to MBIA's restructuring and an offer to prop up AIG's financial products unit, NYID allowed XL Capital to commute its obligations to XLCA, a transaction that voided valuable protection for many policyholders and reduced the pool of assets available to protect all policyholders.
  7. Why haven't one or more attorneys general investigated MBIA's restructuring, which effectively confiscated assets from insureds and gave it to shareholders and management?
  8. How could MBIA's auditors and actuaries allow MBIA to record such optimistic loss estimates in the face of data that supports much larger losses?
  9. How does S&P justify an investment grade rating for MBIA Insurance Corporation? MBIA Insurance Corporation is extremely leveraged and assumes credit risk on highly correlated below investment grade credits many multiples of Statutory Surplus.
  10. Regardless of the notional capital available to support MBIA Illinois, how does S&P justify the AA- rating despite numerous lawsuits that threaten the operation and a management team that recently raided the assets of a company it manages?

Reggie Middleton Historical Opinion on MBIA:

A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton ,

Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billi

Follow up to the Ambac Analysis ,

Monolines swoon, CDOs go boom & I really wonder why the ratings agencies are given any credibility,

What does Brittany Spears, Snow White and MBIA have in Common? ,

Moody's Affirms Ratings of Ambac and MBIA & Loses any Credibilty They May Have Had Left

Download a "Window" into Ambac's Problems

1. Is MBIA About to Pull the Wool Over the Market's Eyes?
(Reggie Middleton's Boom Bust Blog/MyBlog)
I would like to make it clear that MBIA and the other monolines have assisted the investment, commercial and mortgage banking industry in the significant inflating of the perception of capit
Sunday, 22 February 2009

2. Another one of those "I told you so's!"
(Reggie Middleton's Boom Bust Blog/MyBlog)
...espect out of the institutional circles... From Bloomberg : April 7 (Bloomberg) -- MBIA Inc. was sued by Third Avenue Management LLC, the New York company founded by mutual fund m...
Tuesday, 07 April 2009

MBIA, Ambac and the joke that is no longer funny
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)

... be the world's most respected financial center. From Bloomberg: MBIA, Ambac Losses Elevate Aaa Concern, Moody's Says MBIA Inc. and Ambac F...
Tuesday, 13 May 2008
Reggie Middleton on Assured Guaranty
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
...or grade investments in its insured portfolio. While stocks of other bond insurers, specifically Ambac, MBIA and Security Capital Assurance, have fallen sharply over the last few months, AGO has saile...
Saturday, 22 March 2008

The Next Shoe to Drop: Credit Default Swaps (CDS) and Counterparty Risk - Beware what lies beneath!
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
This is a DRAFT of part 3 of Reggie Middleton on the Asset Securitization Crisis – Why using other people’s money has wrecked the banking system: a comparison to the S&L crisis of 80
Thursday, 08 May 2008

Last modified on Wednesday, 13 May 2009 01:00


  • Comment Link angus Thursday, 14 May 2009 09:19 posted by angus,22049,24026405-5006009,00.html
    says other partners in this toll road have written down the value of their stakes to zero but MBIA has not

  • Comment Link Reggie Middleton Wednesday, 13 May 2009 22:54 posted by Reggie Middleton

    [quote]Bank of America, JPMorgan Sue MBIA Over Unit’s Split (Update2)[/url] Bank of America Corp., JPMorgan Chase & Co., UBS AG and 15 more of the world’s largest financial companies sued MBIA Inc., saying the biggest bond insurer’s split of its guarantee business illegally cut their odds of getting paid on policies.

    MBIA stripped $5 billion of assets out of its MBIA Insurance Corp. division to fund a new unit amid “an ongoing financial crisis that has made it increasingly likely that MBIA Insurance will have to pay out billions” of dollars, according to the complaint filed today in New York State Supreme Court in Manhattan.

    The case adds to two previous lawsuits filed by funds over the February restructuring by Armonk, New York-based MBIA, which New York State Insurance Superintendent Eric Dinallo approved. Banks concerned that the split of the business hurt them had met with state regulators in March, David Neustadt, a spokesman for the New York State Insurance Department, said at the time.

    The decision to move assets from the unit and “render it effectively insolvent was a blatant attempt to enrich MBIA Inc. and its management at the expense of MBIA Insurance and its policyholders,” Vince DiBlasi, a lawyer who represents the group at Sullivan & Cromwell LLP, said in an e-mailed statement.

    The group also includes Barclays Plc, HSBC Holdings Plc, Citigroup Inc., Canadian Imperial Bank of Commerce, BNP Paribas, Royal Bank of Canada, Morgan Stanley, Sumitomo Mitsui Financial Group Inc., Societe Generale, Credit Agricole SA and Wells Fargo & Co. or their units.

    ‘In Secret’

    The companies “are among the world’s leading financial institutions, which previously have worked with distressed insurers to reach negotiated solutions that maximized value and respected the interests of all stakeholders,” according to their complaint. MBIA’s restructuring, by contrast, was designed “in secret,” they said.

    Kevin Brown, a spokesman for MBIA, and Neustadt declined to immediately comment.

    MBIA Chief Executive Officer Jay Brown is seeking to use the restructuring to re-enter the municipal-bond business, after record losses on mortgage-backed debt amid the worst housing slump since the Great Depression.

    Brown’s efforts to salvage MBIA, where he reclaimed the CEO title in 2008 after three years as chairman, also involve bids to recoup home-loan losses through the courts, with actions including suits against Bank of America and GMAC LLC.
    Hedge funds run by Aurelius Capital Management and Fir Tree Partners alleged in their suit, filed March 11, that “the federal government is one of the largest victims of this looting,” after the U.S. agreed to share losses on some banks’ assets and injected capital into more lenders.

    Martin Whitman’s Third Avenue Management LLC, MBIA’s second-largest shareholder as of Dec. 31, according to data compiled by Bloomberg, said in an April 6 suit that the separation devalued notes it holds that were issued in January 2008 by the unit in a bid to save its AAA ratings.

    ‘Without Merit’

    MBIA believes that the previous litigation “is without merit and intends to contest it vigorously,” the insurer said in its quarterly earnings statement May 11.

    Because New York regulators approved of the “transformation,” any challenge to it should be brought as a so-called Article 78 proceeding under which official actions are contested, not as a civil case, the company said.

    Rob Haines, an analyst at CreditSights Inc. in New York, wrote in a report yesterday that the split is a “necessary step to sustain the company as an ongoing entity” and “unlikely to be scuttled,” based on his recent conversations with state regulators.

    Officials told Haines that they had conducted “rigorous testing” of MBIA Insurance’s capital, he wrote. “While there is no quantitative test that dictates when such a transaction is acceptable, the superintendent is legally vested with a great deal of authority and discretion around these types of actions.”

    Buyback Offer

    Wisconsin Insurance Commissioner Sean Dilweg, who oversees competitor Ambac Financial Group Inc.’s main unit, said in a March interview that “we’ve always had concerns with splitting the book because you get into drawing lines and giving preferences,” referring to New York-based Ambac’s guarantees.

    MBIA today offered to buy back preferred stock issued by the insurance unit for 10 cents on the dollar.

    Brown said on a conference call yesterday that about 66 percent to 80 percent of his insurer’s losses on second-mortgage bonds and mortgage-related collateralized debt obligations, its two worst insurance categories, are tied to collateral that was “ineligible” to be included in the deals, and so its guarantee payouts may be recouped, either through negotiations or suits.

    MBIA President Chuck Chaplin said on the call suits against it over the split “will likely have some impact on our marketing in the short run” as MBIA attempts to win new municipal-bond business with the National Public Finance unit.

    The case is ABN Amro Bank N.V., Barclays Bank PLC, et al. v. MBIA Inc., MBIA Insurance Corp. and MBIA Insurance Corp. of Illinois, 601475/2009, Supreme Court of New York (Manhattan).

    To contact the reporter on this story: Jody Shenn in New York at [/quote]

  • Comment Link phirang Wednesday, 13 May 2009 20:39 posted by phirang

    literally worth less than 0.

    That it's above 0 leaves little wonder to why C is above 1 and BAC above 5... :D

  • Comment Link jarret Wednesday, 13 May 2009 20:15 posted by jarret

    Great posting Mark....thanks to you and Reggie for sharing it.

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