Tom A's Stock Picks

Bond insurers update - MBI & ABK

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Events continue to unfold in the ongoing saga of my investment in bond insurers MBI & ABK.

Warren Buffett very kindly offered to put them out of the municipal bond insurance business by reinsuring 800 billion of their combined portfolios at 1.5 X the premium they received. He presented it in a manner that suggested he was doing the world a favor, and their stocks rallied briefly until investors read the offer more carefully and noted the negative implications for bond insurers - that they had no recourse but to be bailed out by the Oracle of Omaha, that they should hand over their extremely profitable business, that they in point of fact would not be able to pay the claims if Warren didn't step in. Of course, none of this is true, and Buffett, having had a look at their operations while discussing possible deals, knows that as well as anyone. He seems to be falling short of his reputation for humility and decency.

It should be noted that Berkshire Hathaway has been able to command two times what had been the going rate for municipal bond insurance, which answers the question of whether there is a need and a demand for the coverage. I think it also should make market participants extremely wary of becoming dependent on Berkshire Hathaway. Buffett appreciates the earning power of a monopoly and he would be glad to secure one, if he can, especially if he can also be hailed as a savior in the process.

I enlarged my position in MBI after they completed their stock offering successfully, and again as the stock declined after Buffett's bombshell. Nothing Warren says changes their balance sheet, which has been strengthened by their recent stock offering.

Tomorrow there will be a hearing before the subcommittee of the U.S. House Committee on Financial Services. According to an article from Reuters, MBI in written testimony is taking issue with William Ackman's participation as an "industry expert," noting that he is a short-seller. They go on to suggest that "half-truths and misleading information" should be "investigated and curtailed." I applaud this move on their part. As mentioned in my previous post, "The True Moral Hazard," I think the activities of those who intended to profit from the turmoil in sub-prime and the credit market have exacerbated an already difficult situation and endangered our financial system.

Curiously, I received under the guise of news a couple of blogs that referred to a so called open source Excel Workbook, prepared by Ackman, and purporting to develop estimates of ABK's and MBI's losses using a drill-down method. According to the author of this blog, the losses were "unexceptional." This is an example of the sort of information/disinformation that floats around the blogosphere. As a shareholder of both companies, I emailed them and suggested they secure a copy of this workbook, if it exists, analyze it, and comment publicly.

In the absence of hard information from other sources, I continue to rely on the company's latest loss reserves, which are prepared using conservative assumptions and which have been scrutinized by CPA auditors. The point being, auditors have a definite awareness that this is a sensitive area and I am sure they are putting forth their best efforts. Witness the situation which developed around AIG's bond insurance business - their auditors wrote them up for defective internal controls because they didn't have information to back up an adjustment to their Mark to market losses. I note the stock tanked although the news really didn't change the actual loss picture at all.

In terms of solutions to industry problems, I take issue with John Freeman's suggestion that the bond insurers are or soon will be insolvent and that an appropriate solution would be for the government to sell their bond business to Buffett and then guarantee sub-prime to the tune of 250 billion. His blog is not set up to accept comments or I would post one there. To begin with, not all bonds backed by sup-prime collateral were insured, and MBI and ABK as of this moment have claims paying resources large enough to pay the maximum probable losses on what they insured, well in excess of any realistic estimate. Their primary problem is the inability to raise capital under affordable terms, due largely to the hysteria whipped up by short-sellers and a sensationalist press, coupled with the moving target provided by the rating agencies, who are changing their methods and requirements at regular intervals, basically to appease a market that is angered by their role is creating the sub-prime problems. For MBI and ABK, and the whole credit system, a government guaranteed line of credit of a few billion would stop this whole thing dead in its tracks. Dirt cheap at the price and even that wouldn't be necessary if market participants were more resolute in looking at things more from the standpoint of the facts and less from standpoint of hysterical fears or greedy manipulation.

As a concluding remark, I am in the process of modifying my investment strategy and transitioning my portfolio accordingly, to consider momentum factors as well as value. Among other things, that means is that going forward I will not involve myself in situations where there is heavy traffic in misinformation, distortions, and half-truths. The point being, a sufficiently determined band of short-sellers can create amazing negative momentum. However, I have carved out a special place for my positions in ABK and MBI and plan to hold them until the questions about their ultimate losses and capital adequacy are clarified by future events. I expect to show a profit, or at the least a serious reduction of my current unrealized losses.

Tom