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January 12, 2008

MBIA in the News Recently... I am not going to say I told you so
by Reggie Middleton

Now, I am far from a fixed income specialist, but I just couldn't resist commenting on this...

From Reuters:
Investors may snap up a planned $1 billion debt sale by a unit of MBIA Inc, after the beleaguered bond insurer was forced to ramp up the deal's yield to about 14 percent to attract greater interest, according to investors familiar with the deal on Friday. The issue of so-called surplus notes by MBIA Insurance Corp. is part of an effort by the bond insurer to buoy capital and preserve its "AAA" rating. Investors on Thursday said dealers were negotiating a coupon rate between 9 percent and 12 percent, or as much as double what similarly rated bonds offer. "They had problems getting it done at the levels that were initially talked about," said Mirko Mikelic, a portfolio manager at Fifth Third Asset Management in Grand Rapids, Michigan. "When they bumped it out to 14 percent, it got a lot of people out of the wood work." At nearly twice the prevailing rates, what do you expect?

Surplus notes, unique to insurers, can bolster MBIA's balance sheet since they can be classified as equity. Pricing on the issue, initially expected this week, is uncertain, said another investor, who declined to be named. Delayed pricing may be due to negotiations over protections demanded by some large investors against a five-year call feature, he said.

Not mentioned here is the risk of MBIA tripping its net worh covenants, due to the drawdown caused by marking to market. I warned of this at least two months ago, but I am not going to say I told you so. Specifically, Ambac is at risk with their Citibank $400 million credit line, and MBIA with their $500 million credit line.

From Marketwatch:
A general pricing guideline for surplus notes would be 100 basis points higher than the spread of an existing bond from the company with a similar maturity. MBIA's 7.15% issue due 2027 is being traded at 488 basis points over Treasurys, according to data from MarketAxess.

From Dow Jones:
MBIA Inc. (MBI) faces a purported class-action lawsuit for violating federal securities law from Jan. 30, 2007 through Jan. 9, 2008, according to the law firm Bernstein Litowitz Berger & Grossman LLP.

Representatives from MBIA couldn't be immediately reached for comment.

The Armonk, N.Y., financial services company is alleged to have issued false and misleading press releases, financial statements, filings with the Securities and Exchange Commission and statements during investor conference calls regarding its expose to losses stemming from MBIA's insurance of residential mortgage-backed securities. I am not going to say I told you so, am I?.

The suit alleges that in doing so, MBIA violated section 10b of the Securities Exchange Act of 1934 and rule 10b-5.

MBIA's chief executive and financial chief were also named in the suit.

From Bloomberg:
MBIA Inc., the largest bond insurer, is offering to pay a yield of about 14 percent on its $1 billion of AA rated notes, a rate usually charged to the lowest-ranked borrowers.

The yield would be 3.125 percent higher than what Greenwood Village, Colorado-based First Data Corp. paid in October when it sold $2.2 billion of bonds to finance its leveraged buyout by Kohlberg, Kravis Roberts & Co., according to Merrill Lynch & Co. index data. It is also more than a 140% (or 840 basis points) premium over B of A's AA notes, indicating AA can mean a lot of different things to a lot of different people. If surplus notes normally demand a 100 point spread, we are in uncharted territory here. I know Moody's and I have two dstinct interpetations "investment grade". I think the market differs with Moody's on this one as well. But hey, I am not a fixed income guy so I don't know this stuff that well. I'm rather well endowed in the good 'ole common sense department, though.

Short interest in MBIA was 46 million shares as of Dec. 31, more than double that of a year earlier as hedge funds including William Ackman's Pershing Square Capital Management bet the stock will decline further. Short sellers sell borrowed stock in the hope of profiting by repurchasing the securities later at a lower price and returning them to the holder. Credit-default swaps on MBIA rose to distressed levels as investors demanded 12 percentage points upfront and 5 percentage points a year to protect MBIA bonds from default for five years, according to broker Phoenix Partners Group in New York. The price means it costs $1.2 million upfront and $500,000 a year to protect MBIA bonds from default for five years. So, Moody's/Fitch and the market are at least 500 basis points in disagreement. Somebody's wrong. Fitch admitted that they factored into their investment grade modeling HPA (housing price appreciation) that would go on in perpetuity- that is that housing prices would never go down. Taking this into consideration, my bet is against the ratings agencies.

CDO Losses - MBIA, which gets 90 percent of its revenue from insuring state, municipal and structured finance bonds, reported profits every year for at least the past 16 years. Net income in 2006 rose 15 percent to $819 million. But they are taking unprecedented losses now. The $737 million expense includes $614 million set aside to cover losses on home-equity loans, MBIA said today. The value of CDOs the company insures has slumped by $3.3 billion before tax, MBIA said. That includes about $200 million that MBIA expects to pay claims on. I'm not going to say I told you so.

The losses forced MBIA to ask Barclay's Bank Plc to change terms of a credit agreement to help it avoid breaching a net- worth condition because of the losses, according to a regulatory filing today. I'm still not going to say I told you so.

The company said the losses aren't "predictive" of future claims. He's right. Future claims are probably going to be worse...

The insurer is among some of the biggest U.S. financial institutions seeking money from outside investors to shore up capital after the value of corporate loans, subprime mortgages and CDOs slumped, causing more than $100 billion of losses. It's too early to say MBIA is safe from a ratings downgrade, said Ed Grebeck, chief executive officer of debt consulting firm Tempus Advisors in Stamford, Connecticut. Ratings downgrade or not, I think we all now realize that poorly capitalied, highly leveraged insurance of structured derivative products with minimal loss history and ambiguous recovery procedures are a sham, and that's putting it nicely. This leads me to believe that agencies who rate this sham AAA, or even AA, are shams themselves. See the following:

• 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,
• and Download a "Window" into Ambac's Problems

Basically, these amount to a bunch of "I told you so", but you didn't hear that from me.

"Nobody knows how much capital is really needed to recapitalize this business properly," said Grebeck, who is also an adjunct lecturer in credit derivatives at New York University. "Rating agencies models have failed in structured credit and CDOs." This is about the most accurate thing I have read in the news as of late.

Now, back to those AA bonds trading at Junk + spreads. Let's take a look at a smorgasbord of junk offerings so we simple laymen (and women) can try to grasp the outstanding opportunity that we, as qualified purchasers, may have before us in getting investment grade debt at more than twice the yield of treasuries, at par even.

"It was expensive but they needed to get it done," said Kevin Murphy, who oversees investment-grade and emerging-market bonds at Boston-based Putnam Investments, which has $65 billion in fixed-income assets under management. "It's good news for the company, good news for the bond insurance sector and good news for the credit markets." I don't know exactly how he is coming to this conclusion. Good news would have been getting the deal done at 5.8%, not 14%. 14% screams J-U-N-K, and yes, I used all CAPS. Let's count the ways MBIA can diss their investors in the near future:

1. Declining revenues from lower demand from municipalities,
2. structured product market drying up (which had the highest margins),
3. extreme competition from Buffet,
4. the debt service of 14% billion dollar debt,
5. the dilution of earnings from the ceding to reinsurance companies,
6. the ongoing marking down of inventory
7. the rate at which CDOs are defaulting and liquidating
8. the investments (CDOs) that MBIA made that are blowing up
9. the trouble that municipalities are now facing from expanding their budgets too much during the bubble and now facing lower and defaulted property taxes as well as lower corporate tax revenue,
10. the increased defaults in consumer finance products
11. the big daddy of them all, the real estate bubble burst is JUST BEGINNIING, and has a long way to go.

"MBIA needs the money to bolster capital and stave off a reduction in its insurance unit's top credit rating. Fitch Ratings gave MBIA until the end of the month to raise at least $1 billion. A loss of the rating would cripple MBIA's business of insuring debt." Okay, now I know I must be a maverick. I really, really believe that any company that needs to offer 14% yields in a 5.5% market simply is not AA quality. Those junk level spreads in MBIA's CDSs seem to be agreeing with me. Moody's insist they are investment quality though. Hey, that's what they get paid for, and as I disclaimed earlier in the article, I am far from a fixed income specialist. I'm fairly well endowed in the common sense department, though.

"MBIA said this week it would sell the notes and cut its dividend 62 percent to help increase its capital. In December, the company said private equity firm Warburg Pincus LLC would invest $1 billion in the Armonk, New York-based company." Again, I query, "Are these actions indicative of a AA risk?"

MBIA's yield is equivalent to 956 basis points higher than U.S. Treasuries of a similar maturity. The extra yield, or spread, on investment-grade bonds is 217 basis points, according to Merrill Lynch index data. The premium to own high-yield, or junk-rated, debt is 663 basis points. A basis point is 0.01 percentage point.

Fourth-Quarter Markdowns

"That would be close to distressed levels," said Martin Fridson, chief executive officer of high-yield research firm FridsonVision LLC in New York. Distressed bonds trade at 1,000 basis points over Treasuries of similar maturity. Close to? Wait until the bonds start trading. My research portends very grim endings for MBIA and Ambac. See Insurers and Insurance in my blog, where I focus primarily on these two companies.

MBIA, down 80 percent in the past 12 months before today, jumped $1.84, or 13 percent, to $15.95 at 3:24 p.m. in New York Stock Exchange composite trading. Marty Whitman's Third Avenue Management LLC more than doubled its stake in the company to 10.98 percent, according to a regulatory filing yesterday.

Earlier this week, MBIA said it expects to take fourth- quarter markdowns totaling $3.3 billion on its guarantees of securities based on home loans made to borrowers with poor credit. You ain't seen nuthin' yet. Wait until the homebuilders start truly going into liquidation mode all the while competing against the ramp up of REOs on the bank's books who will be competing against the existing homeowner trying to sell and the investor who can't flip or rent long term at neg. cash flow thus walks away - all significantly devaluing the assets that underpin the structured products and MBS/ABS that MBIA insures. What we have seen thus far is just the beginning.

"Obviously, there are problems in wonderland," said Alan Kral, managing director of Trevor Stewart Burton and Jacobsen, a New York-based investment adviser with $750 million under management, including shares of MBIA." You really do think so???

See the Insurers and Insurance postings for my past opinions on this topic. For info on the homebuilders and their insolvencies see Residential Real Estate and a heads up warning concerning the upcoming commerical real estate crunch is available in this series of articles - Commercial Real Estate. As usual, there are plenty of downloadable reports, mini-apps and exhibits as well.

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

Who am I?

Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I am definitively outside the box - not your typical or stereotypical Wall Street investor. I work out of my home, not a Manhattan office. I build my own technology and perform my own research - in lieu of buying it or following the crowd. I create and follow my own macro strategies and am by definition, a contrarian to the nth degree.

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Copyright © 2007-2008 Reggie Middleton

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