MBI - MBIA Inc.

[valuecfa]

I have initiated a long position in MBIA, inc.  This controversial investment has its share of investment gurus on both sides of the table, long and short. I am siding with the longs on this one, and have enough conviction to make a long purchase.

 

Instead of going into a long valuation based approach, i will let you do that on your own (focusing on each subs book value and provisions), and focus on 2 key variables that will make the company substantially more valuable than current prices. The first is the split of the company into 2 subsidiaries National and MBIA corp., effectively "walling off" the liabilities of one from the other. This was done over a year ago, after being approved by its regulator, the New York Insurance Dept. after reviewing the assets and claims paying abilities of the subs individually. The NYID approved this after thorough analysis. The defendants claim that the regulator didn't do enough due diligence on the company, before coming to this conclusion, and that they may not have the authority.

 

The benefit from winning this case is that even if the structured finance unit goes to zero the book value of National (the municipal unit) would flow directly to MBIA. Effectively, you could view the structured finance unit as a call option if you view it unlikely to remain a going concern. Jay Brown has been quoted as saying that the National side (good side) will not subsidize the losses of the Structured side (the bad side), which is why they did the split. Coincidently, this is similar to a proposal that Bill Ackman came up with. So, MBIA is being sued by a bunch of banks that claim the split is illegal, in an attempt to protect their structured finance interests. Other funds like Third Avenue have sued, as they have held the bonds of the subsidiary. This group is holding their hat on an Article 78 proceeding that claims that the regulator acted arbitrarily and capriciously by approving the transformation. So they have to basically prove that the regulator (NYID) did not do their job properly. This will be very difficult to prove, as the subsidiaries remain solvent to this day and continue to pay all claims come through. Further NYID's stress tests of the subs. were done both internally, as well as via a third party opinion.

 

The second issue of major importance is the "put-back" issue. MBIA (as well as other guarantors, investors, GSE's, etc) are claiming that the banks violated the representations and warranties they made when selling mortgage-backed securities, and in some cases committed fraud. This is a major, major issue for the banks that it not getting nearly the attention it deserves. I won't get into the possible magnitude of that though. I'll just focus on MBIA's expected recoveries. MBIA has (questionably) already booked over $2 billion in discounted expected recoveries on their books from this issue. On the latest investor call, the company noted that this number is likely to get closer to $4 Billion as we get closer to late 2011, early 2012. MBIA is able to claim this on the books as they see the damages collected as highly probable. Interestingly, the defendants have not added the corresponding liabilities to their books yet. I think there is an extremely high likelihood that they will be victorious in putting back all the deceptive securities to BAC (Countrywide), GMAC, Merrill Lynch, Morgan Stanley, etc. It is obvious to most that the banks were deceptive in the selling off these pooled securities and having the insurers guarantee them. There are many to blame, but i think the banks are at the top of the list. Instead of linking to various articles and suits alleging fraud, misrepresentation, etc, one can Google all the lawsuits the likes of Bank of America (Countrywide, Citi, JP Morgan, etc) are receiving  from guarantors to investors, to GSE's, to states and municipalities.

 

A highly circulated, worthy presentation to review that largely breaks most of this down into a simple PowerPoint presentation can be found here:

http://www.businessinsider.com/manal-mehta-mbia-presentation-2010-10#

 

I put the probability of success in both issues as highly probable given the facts i have reviewed. This is my opinion. It is worth noting that the likes of Einhorn as well as T2 have been short the company in the past, and may continue to hold short positions. There are reputable longs on the other side, the largest of which is the Fairholme Fund. If you watch his last interview he gave on Wealth Track Bruce Berkowitz notes that MBIA is his number 1 pick for a diversified portfolio. Video can be found here:  http://www.gurufocus.com/news.php?id=105736

 

In it he briefly discuses why MBIA is his number one pick. In addition, you can view this article that touches on his MBIA thoughts in greater depth: http://www.bondbuyer.com/issues/119_394/fairholme_capital_mbia-1015414-1.html

 

Aside from the two litigation issues I mentioned above, which Berkowitz also views as having likely positive outcomes, he mentions in the Wealth Track video that MBIA has "tremendous arbitrage opportunities" without saying what they are. I could find no indication of what arbitrage possibilities he was referring to by scouring the Internet. Upon researching the company in more depth and thinking about the possibilities,  I think he was likely referring to the following type of arbitrage.

 

As an example, if a guarantor buys a RMBS wrapped by itself, say at a depressed market price of 20 cents on the dollar, economically the guarantor is then no long exposed to potential claims from the RMBS because it essentially pays itself given a claim. However, the guarantor can have a gain if the ultimate loss of the RMBS is less than 80 cents. For example, if the ultimate loss is 60 cents, the guarantor receives 40 cents from owning the RMBS. This leads to a net gain of 20 cents, a 50% return on investment, for the guarantor as opposed to an insured loss of 60 cents. Effectively, MBIA would be buying wrapped RMBS at large discounts, thereby reducing large payouts to third parties, and giving them some potential upside. This is a completely overlooked tool that can provide tremendous results.

 

This is the only type of arbitrage activity I could think of that Berkowitz might be referring to. In addition the company continues to reach agreements with counter parties on commutation of exposures on their CDS contracts. A recent agreement eliminated $4.4 billion in gross insured exposure in exchange for a one-time payment by MBIA Corp. of $72 million. ( $34 million after reinsurance).

 

All in all i think MBIA will be a huge winner, yet one can easily see the risks involved. Please do your own due diligence.

 

Sorry i didn't format this well, I'm trying to rush this out before i go to dinner  :D

 

 

[mpauls]

You could place a bet on both sides of pending litigation.

[ERICOPOLY]

valuecfa,

What do you understand about this "adjusted book value" that they make so much mention of in the annual report.  The stock traded at about 90% of ABV in 2007, but today it trades at a bit under 30% of adjusted book. 

 

Is it reasonable to make the connection that adjusted book value suggests a 3 bagger as the upper bound of what you can reasonably expect to make in the stock?  (once the smoke clears of course).

 

Or is it somewhere explained in that annual report that adjusted book is temporarily depressed for some reason?  I guess I'm trying to read this thing for the first time and am really confused by all the "adjustments" they make.

 

[Rabbitisrich]

I am looking at MBIA because of this thread and so far it's a doozy to figure out.

 

ValueCFA, are you sure that the banks can only proceed by attacking the regulators' actions? According to this ruling from Feb. 17 2010, http://www.courts.state.ny.us/REPORTER/3dseries/2010/2010_50238.htm, the company tried to dismiss the fraudulent conveyance and self-enrichment motions by claiming that such issues fell under the purview of the regulators. But the judge found that MBIA could not establish, at that time, that the plaintiffs could only pursue litigation against the authority and discretion of the regulating agencies.

 

 

From the paragraph above Part C in the document:

 

Based only on the February 17th approval letter, the scope of the Superintendent's approval is not clear enough for the Court to hold that plaintiffs' claims fail as a matter of law. It may [*16]well be, following limited discovery that DOI's review can be shown to be co-extensive with and preemptive of plaintiffs' claims. However, at this stage of the proceedings, that determination cannot be made without further discovery and affirmation.

 

[valuecfa]

Rabbitisrich,

 

Sorry. There is more than one case regarding the litigation related to the separation of the business. From my writeup it may be implied that there is only one case to be heard (on this issue), which is not the case. Several cases concern the separation

 

Ericopoly,

 

Pages 98-99 of the Q explain the adjusted book value metric in greater depth, including a reconciliation. I could explain it more a bit later when not busy.

 

Cheers.

[txlaw]

Two interesting developments in the MBIA story:

 

http://www.bloomberg.com/news/2010-12-22/bofa-loses-evidence-ruling-in-mbia-fraud-suit-over-21-billion-in-coverage.html

 

http://www.bloomberg.com/news/2010-12-22/mbia-credit-ratings-lowered-by-s-p-on-potential-cdo-losses-litigation.html

 

 

 

 

[Rabbitisrich]

Txlaw, thanks for those links. Handicapping judicial processes is way out of my league.

 

ValueCfa, I think we are talking about the same case. From the linked decision, I don't think that MBIA has established that article 78 forces the banks to prove that the regulator acted capriciously or arbitrarily. As I understand, the judge put the onus on MBIA to prove that the regulating agencies determined the fairness and equitableness of the transaction, rather than acted as a simple problem solver.

 

Do you view the company as a safe buy on a consolidated basis? I haven't done the runoff math on MBIA Corp. but I'm not a fan of moves like deducting projected legal winnings from loss reserves.

[valuecfa]

Adjusted book value (ABV) is something MBIA mgmt. and other bond insurers use. It has come in handy since FAS 157 (mark to market accounting). It largely explains the distortion that the new accounting rule created. Had FAS 157 never occurred, GAAP book value would be significantly higher at this time.

 

GAAP book value under the new rule seriously understates the value of a bond insurance company like MBIA that also sold volatile structured products like CDS. As the value of these contracts (on the secondary market) is traded they are market to market each quarter. Remember, the mark to market is tracking the fair value of the instrument MBIA guarantees. But MBIA doesn’t guarantee the market value. They guarantee against defaults. Therefore, mark to market accounting does not accurately reflect the economics of their business. Now the important thing to note is that these contracts are insurance, and MBIA doesn't pay out any cash unless there is a default. So fluctuations in their market value are irrelevant in relation to the underlying contract until a default occurs. Mark to market does however serve the purpose in explaining the current stresses in those contracts.

 

As you may have noticed MBIA's GAAP earnings (and the corresponding GAAP book value) are all over the place jumping up or down over $1 Billion each quarter. MBIA is neither earning nor losing that billion or two each quarter for the reasons explained above. There is a lot of noise in the GAAP accounting since this rule change.

 

There are several adjustments made in the Adjusted Book Value calculation that you can see on pg. 98-99 of the 10-Q. I'll focus on the big ones of recent quarters (The Q can explain all the rest of the smaller adjustments). The majority of the difference b/t GAAP and ABV in recent periods are from the unearned premium revenue, the cumulative impairments on insured derivatives, and cumulative unrealized loss on insured credit derivatives.

 

Under ABV, they add back unearned premium revenue b/c this is the value of the revenue in which they have already received, adjusted for a loss provision that mgmt estimates. MBIA earns this money upfront all at once (unlike installment premiums on their CDO guarantees which are annual premiums in which the PV of these premiums is added back as well). For the unearned premium revenue, they have the cash in the bank already, but they can't report it as an asset yet b/c  the revenues have to match the expenses over the life of the contract so they report the income slowly every year. So it makes sense to add it to GAAP book value (adjusted for losses), especially in a runoff scenario.  

 

Another major factor in the ABV is the cumulative impairments on insured credit derivatives. The company makes estimates each quarter on how much they should impair their contracts b/c they view the contracts in extreme distress and likely to default. It makes sense in a period where mark to market assets are deteriorating to increase impairments. Basically, they say you should use their impairment figures on the contracts on not mark to market accounting. These impairments are subtracted from GAAP book value in determining ABV.

 

The other major adjustment to get to ABV is by adding back he mark to market losses on the contracts. Remember, as explained earlier, the market value is irrelevant (except that it may show the stress on those contracts). MBIA doesn't guarantee against loss in market value they guarantee against default. Therefore, you add back the market value changes. Instead, the company's impairments (mentioned in the paragraph prior) are  used to calculate the economic changes in the value of those contracts.

 

The new rule creates a lot of noise in MBIA's earnings and GAAP book value. This is an attempt to normalize everything. This is why there is a large discrepancy between GAAP book value and Adjusted Book Value. Now the big question you have to ask yourself is do you believe the provisions and impairments in place are accurate relative to the stresses in both the municipal market and the structure finance market. Mgmt has vastly understated estimated their structured finance losses over the past 2 years, and they honestly have an incentive to continue to understate it as the trial progresses over the company's transformation. The more healthy they make that unit look the better it looks in the trial. Are the structured finance impairments reflective of the future defaults. I don't know. This market was very healthy just a few years ago. Will the pace of defaults begin to decline in a more rapid pace as the economy improves and credit loosens? Are the mark to market losses over stating the future reality and likely defaults? This is what you have to ask yourself when valuing the structured finance unit (if you think it has any value at all). The municipal subsidiary is the obvious gem of the two businesses. Both businesses are currently not writing any business. The municipal subsidiary would like to write new business and is perfectly capable if the separation is held up in court. If the separation is valid and legal than they would likely get an immediate investment grade rating for that subsidiary and begin to write new business again at much better prices than they have in the past.

 

Another important thing to note is that in the event that an insured bond defaults, they typically have the option to either continue making the periodic principal and interest payments over the remixing life of the bond or the company can accelerate the bond and pay off the obligation in its entirety - whichever has a superior outcome for them. This is a valuable option that can result in the ultimate payment of principal being far out in the future, giving the underlying credit or asset pool time to recover and reduce any loss to MBIA.

 

The ""putback" cases, if won, may make the separation issue less relevant  should the judge force the subsidiaries to combine again. MBIA is seeking billions in recoveries that may largely revert most of the past losses from recent years back to the company. My investment in the company doesn't depend on litigation, however a separation of the structured finance unit would take away a great deal of uncertainty. I believe the runoff value to be higher than the market value, however the inherent volatility/uncertainty in the structured finance unit makes this a more difficult estimation (This isn't a stable asset to which you can assign a specific value too, like normal assets such as inventory or equipment. This is very subjective). The legal separation of the subsidiaries would take away additional uncertainty that the structured finance sub creates. The putback cases are just the icing on the cake as the expected recoveries are even larger than the current value of the company.

 

Update: the recent credit downgrade today is irrelevant as the company is not writing any new business in either unit. It is expected that the structured finance unit will maintain a below investment grade rating, which MBIA is fine with. The lack of clarity over the separation of the subsidiaries, as well as the recent stresses and uncertainty in the structured finance sub is causing a downgrade in the National sub as well. A lack of legal separation of the subsidiaries will cause the National subsidiary to not have the opportunity to write new business, unless/until substantial putback recoveries are guaranteed. I should note legal expenses are ballooning to astronomical levels right now, so the recent allowing of statistical sampling is a major victory and time savor.

 

[ERICOPOLY]

valuecfa,

thank you.  immensely helpful.

 

cliffs notes for anna karenina.

 

[Packer16]

How does MIBIA compare to Assured Guarentee which is in better shape and still writing policies?

[valuecfa]

How does MIBIA compare to Assured Guarentee which is in better shape and still writing policies?

 

I'm still in the process of researching AGO.

[prevalou]

What impresses me is the amount insured (net more than 700B$, gross 1000 B$) compared to claim paying resources (about 15B$). there is no room for a lot of losses. Same remark for AGO.

[valuecfa]

 

 

ValueCfa, I think we are talking about the same case. From the linked decision, I don't think that MBIA has established that article 78 forces the banks to prove that the regulator acted capriciously or arbitrarily.

 

 

Sorry, i missed your question in the thread earlier. The Article 78 is currently going along side the other D/C suit. MBIA has appealed the D/C suit. We will know soon if judge will allow both methods. I think no matter which method is used, MBIA will prove successful, though Article 78 would be more difficult for the plaintiffs. Several analysts i spoke to covering the company expect MBIA to win regardless of the method of attack.

 

 

Packer,

 

AGO doesn't have as much potential as MBIA, yet it is indeed a safer company that is undervalued. I don't see their TRUP exposure being an issued given the governmental support. I'm still looking into the company though will likely nibble on AGO as well.

 

[prevalou]

Valuecfa, could you explain where is the margin of safety when Mbia has only 2% reserves+capital vs amount insured and a significative part of this is junk mortgage and cdo? I can't get this point.

[valuecfa]

prevalou,

 

What kind of default rates do you expect?, is probably the question you should ask yourself.

 

I am valuing MBIA Corp. assuming that 50% of the unrealized loses will be recovered. The GAAP book of MBIA Corp is already marked to its current stress levels by the market. I believe these mark to marks are near their plateau sometime in 2011. I obviously believe the structured finance unit has value as its GAAP book value shows as well. Further i think you are going to see large commutations come about in the structured finance unit in the coming quarters. They already commuted half of their riskiest products (CDO-squareds) last quarter at a fantastic price.  As time goes on this will get amortized as well. If i remember correctly, about 10% of the structured finance exposure will be amortized by the end of 2011.

 

As for National Finance, i think they are very adequately reserved, especially given the quality of Nat. Fin's portfolio breakup. 

 

A Moody’s report that examined the cumulative default rate of muni bonds from 1970 to 2006 averaged 0.1 percent for all investment-grade municipal bonds. The default rate for single-A bonds was less than that: 0.03 percent. Or, less than that of a triple-A rated corporate bond.

 

As an example, during the Great Depression the default rate increased to 7% (according to the National Bureau of Economic Research). However, the default rate ultimately amounted to only a 0.5% loss rate for investors as municipalities paid most debt obligations back at full value within 18 months. The result was a municipal default rate of 0.5 percent. This was with 25% unemployment and an economy in severe contraction that lasted a good length of time. The only state to default at that time was Arkansas, yet even then investors were repaid 100 cents on the dollar.

 

If you are worried about the MBS/CDO portfolio you could always wait to see how the litigation goes with the transformation. However, MBIA will likely rally fairly significantly if they get a positive result, as this will take the structured finance questioning completely out of the risk equation for MBIA, and you can put whatever value you want on it.

 

If you look at  National Finance on a stand alone basis (that is giving MBIA Corp a zero GAAP book value as well as a zero Adjusted book value), then National Finance would have about a $16 GAAP book value and a $23 adjusted book value.

 

 

[prevalou]

Thank you very much valuecfa, great information.

Could you explain the commutation? When Mbia commutes 4,4 B$ for 34 m$ net, does it mean that the global loss for Mbia on the cdo is 34m$ or 0,7% of the insured amount?

[valuecfa]

Yes when they commute it they basically pay that price to tear up the contract.

 

In a perverse way the higher MBIA's own CDS are the banks have to mark down the value of MBIA's structured finance insurance, so the worse shape MBIA is in the more they are likely to commute at a great price to help their own books out. If MBIA successfully separates the two subsidiaries there will be a massive flood of commutation requests for the structured finance unit.

[valuecfa]

http://www.cnbc.com/id/15840232?video=1713800375&play=1

 

Link above on Bill Gross's current opinion on Munis. He seems to believe no state will be allowed to default, that he expects continued federal support and is putting his money where his mouth is. He does acknowledge the serious credit situation the munis are currently in. Basically saying the reward/risk is not too shabby at current yields.

[prevalou]

Abv does not take into account operating expenses which are quite real!

They are about 0,8 $ per share and year and with a run off situation it is difficult to ignore them.

[valuecfa]

A few updates that largely explain the reaction in share price over past few days:

 

http://www.bloomberg.com/news/2010-12-29/mbia-shares-rise-after-jpmorgan-drops-suit-over-insurer-s-split.html?cmpid=yhoo

 

http://online.wsj.com/article/SB10001424052970203525404576050143072328106.html

 

A tad premature in my opinion.

[valuecfa]

I don't know if it is the beginning of a trend, or any indication of how the transformation suit is progressing on behalf of MBIA, but it is certainly a positive trend lately.

 

Another bank drops the suit:

 

http://www.bloomberg.com/news/2010-12-31/royal-bank-of-canada-drops-out-of-lawsuit-over-mbia-s-2009-restructuring.html?cmpid=yhoo

[Uccmal]

Hi Valuecfa, Nice work.  I recently reviewed BAC in detail.  As you are aware today (Jan. 3rd) they have cleaned up the GSE side of the putbacks at a final? total cost of 3 billion.

 

They have provided statistics in a recent presentation as to their estimated exposure to non-GSE putbacks.  In total they (BAC/c-wide) sold 160 B that were securitized and wrapped by monolines, to standards substatially less rigourous than GSEs.  Roughly 50% of these have been paid in full as of November 2010.

 

As an estimate of the success rate of monolines getting putbacks on these securities BAC provides the following opposite perspective.  To Sept. 30, 2010 4.8 B in claims had been received by BAC-C-wide.  2.7 B had been reviewed and rejected; 1.5 B were still under review; and 0.6 B had been repurchased.  From this I get that 0.6/3.3 B have been accepted of claims in process at September 30th.  That is a success rate for the monolines of 20% on their total claims to that date.

 

Anyway, something to think about in terms of estimating MBIA's recoveries on these securities.

 

Long BAC Warrants

[valuecfa]

For those following the company, the transformation case against MBIA was just dismissed. It even tripped the circuit breakers, lol.

 

http://www.zerohedge.com/content/mbia-trading-halted-due-single-stock-circuit-breaker

[alertmeipp]

only one of the two got dismissed according to bloomberg... thoughts?

[valuecfa]

only one of the two got dismissed according to bloomberg... thoughts?

 

That is correct. The second, brought under New York state’s Article 78 statute, has yet to be resolved. You can view the decision here: http://www.mbia.com/investor/publications/011111_mbiadecision.pdf

 

 

Does this woman's face freak you out?-

http://www.businessinsider.com/danielle-gilmore-2011-1?utm_source=twitterfeed&utm_medium=twitter&utm_campaign=Feed%3A+businessinsider+%28Business+Insider%29&utm_content=Google+Feedfetcher

 

-long mbia