Is MBIA About to Pull the Wool Over the Markets Eyes?

By: Reggie Middleton | Tue, Feb 24, 2009
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I would like to make it clear that MBIA and the other monolines have assisted the investment, commercial and mortgage banking industry in significant inflating the perception of capital available. If (or more aptly, when) this charade comes to an end (apparently imminently) the banking system will recieve another, quite significant shock to the system. One of several very interesting emails that I received over the weekend.


I am e-mailing about MBIA's recent restructuring announcement, which involves the transfer of $5B out of MBIA Insurance Corporation to one of its subsidiaries, MBIA Illinois (to be renamed). $2.9B of the $5B was paid for MBIA Illinois to reinsure 100% of MBIA Insurance Corporation's public finance exposures. The remaining $2.1B was transferred via a return of capital to MBIA Inc., MBIA Insurance Corporation's parent. Concurrent with the transfer, MBIA Insurance Corporation's ownership interest in MBIA Illinois has been confiscated and transferred to another MBIA subsidiary. On the surface, this wreaks of blatant theft and fraud.

Required reading for this article includes:

  1. A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton.
  2. Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion Market Cap
  3. Follow up to the Ambac Analysis
  4. Monolines swoon, CDOs go boom & I really wonder why the ratings agencies are given any credibility
  5. Bill Ackman of Pershing Square - How to save the Monolines

For those interested in the history, see Insurers and Insurance in m blog. There are literally 100's of pages of opinion and analysis over the last 9 months.

The dominoes should start to fall...
If any body believes I have an inkling of knowing my way around these investment markets, I strongly suggest you re-read my Asset Securitization Crisis series, in particular, "Counterparty risk analyses - counter-party failure will open up another Pandora's box" (must read for anyone who is not a CDS specialist). We wil be entering into the next phase of the crisis, for I believe that the CDS market will start showing fissures that will illuminate rampant counterparty credit risks through the global capital markets. These insurers used CDS almost exclusively for their structured product wraps and insurance.

Based on a detailed review of servicer reports of the majority (several hundred) of RMBS securities bundled into MBIA's CDOs, I believe that this restructuring leaves MBIA Insurance Corporation insolvent by billions of dollars. This is based on optimistic RMBS loss assumptions - mortgage defaults reduce dramatically overnight, almost all 30-89 day delinquencies immediately cure, loan loss severities improve when compared to recent experience. It also assumes no losses from other exposures (e.g., commercial real estate, corporate debt, manufactured housing, auto loans, etc.). Using more assumptions more consistent with market pricing for RMBS and other exposures (e.g., CMBS), the restructuring could leave MBIA Insurance Corp. insolvent by over $10 billion.

The only explanation I can imagine that might arguably justify the restructuring would be the termination of the majority of MBIA's problem exposures at a steep discount. Even this would not truly justify raiding MBIA Insurance Corporation's capital, but it would make it less of a blatant fraud. If there is some explanation that justifies this restructuring, then someone should explain, as this will increase confidence in MBIA's new operation. If there is no valid explanation, then it means that MBIA is in the process of perpetrating a large-scale theft, with the blessing and assistance of New York Insurance Commissioner Eric Dinallo.

I am fearful of speaking out publicly because I work in the insurance industry. At the same time, it would be disgusting if MBIA were allowed to get away with what appears on the surface to be a massive fraud. I am not sure about how to best ascertain whether this restructuring is as bad as it appears, but I have drafted the attached letter as a public appeal for someone to explain.

Unless there is an innocent explanation, the situation deserves a thorough investigation by various authorities, possibly including attorneys general in NY and IL, the SEC, and the National Association of Insurance Commissioners. I think very highly of what you have to say, so I would be greatly appreciative to hear your thoughts.

Appeal to MBIA Management, Stakeholders, and Supporters

As MBIA management and major stakeholders are well aware, short-sellers of MBIA shares (notably Pershing Square and T2 Capital) have released public analyses that project large losses on MBIA Insurance Corporation's structured finance exposures. Recent market prices for residential mortgage-backed securities and RMBS pool statistics suggest that losses might exceed short-sellers' figures. These estimates suggest that the transfer of assets from MBIA Insurance Corp. leaves the company insolvent by a significant margin. In other words, MBIA's recent restructuring announcement reveals a massive scheme to confiscate assets from other MBIA Insurance Corp. policyholders for the benefit of MBIA management and holders of MBIA insured municipal debt.

If MBIA Insurance Corp. is at risk of insolvency, regulators are justified in ensuring a fair allocation of financial resources for public finance exposures. However, if this is necessary, superior protection to insured municipal bondholders by placing MBIA Insurance Corp. under regulatory supervision, without confiscating the residual interests from other stakeholders.

If the restructuring leaves MBIA Insurance Corp. well-capitalized to withstand additional stress beyond short-sellers' loss projections, then it would be very beneficial for stakeholders and the public to clearly understand this. For example, if MBIA terminated the majority of its riskiest exposures at a steep discount to expected losses, this would suggest an improvement in MBIA's financial condition.

The doubt about MBIA's solvency hurts stakeholders by reducing the value of MBIA's common shares, debt, and surplus notes, and severely diminishing the market value of credit enhancement provided by MBIA. Therefore, even if MBIA Insurance Corp. can withstand critics' most pessimistic estimates, MBIA stakeholders would benefit greatly from a public analysis that supports MBIA's reported losses. This letter appeals to MBIA management, stakeholders, and other supporters to provide such an analysis. Such a presentation would be especially persuasive by focusing on two key problem areas: (1) collateralized debt obligations (CDOs) with significant RMBS exposure, and second lien securitizations (home-equity lines of credit and closed end second liens).

When it comes to CDOs, stakeholders would benefit immensely form an examination of one or two representative mortgage-backed securities bundled into one of MBIA's riskiest CDOs, and an estimate of overall losses implied by repeating this analysis for other securities included in the CDO. Stakeholders would also benefit from an understanding of key factors that mitigate losses, including future premium installments, reinsurance, and expected settlements or early terminations.

For second lien exposure, the public would benefit greatly from an examination of one or two of MBIA's riskiest second lien deals, including key assumptions (e.g., roll rates, future delinquencies, prepayment rates) and resulting losses. As with CDOs, it would be extremely valuable for the public to understand factors that mitigate MBIA's losses, like future premium installments, timing of payments, reinsurance, settlements, and expected litigation recoveries.

Aside from MBIA management, a few potential candidates to provide this type of evaluation include Tom Brown, who in 2008 provided a string of analyses of subprime losses that supported investments in MBIA, members of the Warburg Pincus team that invested in MBIA, and Marty Davis, another MBIA investor who has voiced public support. Tom Brown's past blog posts outlined an excellent framework for evaluating RMBS pools. It would be extremely illuminating to understand the conclusions he or others reach by applying this approach to one or two of MBIA's second lien transactions and a representative sampling of RMBS tranches bundled into one of MBIA's riskiest CDOs.



Reggie Middleton

Author: Reggie Middleton

Reggie Middleton

Reggie Middleton

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