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Moody's telegraphed their intentions when they announced their review of Ambac and MBIA, so it was no surprise when both were downgraded. However, the depth of the cut to MBIA, from Aaa to A2, was a surprise. MBIA, in commenting, declared that they were "baffled" by Moody's analysis. Looking over Moody's press release, I see a disturbing picture.
Moody's acknowledges that MBIA has capital consistent with an Aa rating, but nevertheless downgrades them to A2, a total of 5 notches, citing concerns about "aggressive capital management." After they raised capital, MBIA declared their intention to downstream 900 muillion of the proceeds from the holding company to the insurance company, to support the triple A rating. Following S&P's downgrade, which occurred in spite of the fact that their capital met the triple A target, MBI elected to retain the money at the holding company level, and rightfully so.
From a tactical point of view it makes a lot of sense, to hold the funds in reserve and deploy them responsively as situations arise. Ackman made a big deal about where the funds were, and now Moody's is dancing to his tune. I saw Moody's initial announcement that they might downgrade MBIA further than double A as a thinly veiled threat, aimed at compelling MBIA to strand the funds at the insurance company level. MBIA did not comply, and Moody's delivered.
Among Moody's other concerns were the possibility that MBIA might engage in "capital extraction," meaning buybacks or a special dividend. I think the choice of words betrays a desire to denigrate MBIA's motives and justify an excessive rating action. Moody's cites MBIA's lack of financial flexibility, occasioned by a share price that has been pounded so low that raising equity capital makes no economic sense. Because the intrinsic value of MBIA shares is 42.15, buying them back at 5.59 makes an awful lot of sense. A careful review of share ownership shows that much of MBIA's float is owned by Warburg Pincus or other strong value investors: so much so that the repurchase of any meaningful amount of shares would place short-sellers in a very awkward position, having borrowed and sold more shares than they will be able to buy back and return. A nice short squeeze would resolve the share price issue. I find it difficult to believe that Moody's would not understand how helpful it would be to MBIA's situation to do the buyback.
Finally, Moody's "takes comfort" in the fact that the 900 million will be available at the holding company level to facilitate the Asset Management company's activities as it posts collateral and funds termination payments necessitated by the gratuitous severity of the downgrade. Berkshire Hathawy, 19.09% owner of Moody's, and a recent entrant into the municipal bond business, will no doubt also "take comfort." I see an effort to make MBIA's situation as difficult as possible.
At Moody's website, they are now boasting about the accuracy of their ratings, on a one year basis. They seem to have forgotten the criminal negligence which labelled so much garbage as triple A and created this whole mess to begin with. Now they want to prove that they are the tough cop on the beat.
Among the what-ifs is the possiblity that the repurcussions in the bond market from the downgrade will precipitate another game of Insurance as Political Football, with NY Supreritendent of Insurance Eric Dinallo as referee. Dinallo to date has made every effort to be a constructive force in this situation, and I hope he continues. My understanding is that his authority as presently constiututed relates to solvency rather than ratings, and MBIA's solvency is not an issue.
As an investor, I need to keep my eye on the ball - in this case, my value metric. The intrinsic value per share of MBIA still stands at 42.15, the "analytic adjusted book value", as MBIA calls it. This is a nonGAAP metric which adds the present value of future installments and disregards mark to market losses to the extent they are expected to reverse over time. The chances of realizing this value in the best way - by MBIA regaining its triple A rating and writing profitable bond busniness - now seem remote. However, the figure is still a fairly good approximation of the value in run-off.
Somwhere in a back room at Pershing Square Bill Ackman has a wax doll, he sticks it full of pins and mutters various imprecations and incantations against MBIA, Voodoo short-selling, more than half the public believes him, MBIA is doomed, the walking dead. The vociferous drumbeat of negative publicity reinforces the overall effect. I notice recently that a lot of the mentions of his name and techniques are coming with cautions and qualifications, so there is some hope his influence is waning. But I am getting nervous, as he has seriously weakened what was an entirely viable business, almost by brute force of malevolence.
MBIA went over their liquidity situation again after the downgrade, and they issued a press release asserting that they will encounter no problems meeting collateral requirments or termimation payments. I question whether you can move that much money, it's in the billions, without some losses, but I do not expect any liquidity issues.
Krishna Gullapalli, a round one competitor, recently posted a comment on my blog, asking me when I expected to show a profit on my monoline positions. Possibly it was a rhetorical question, but it is one that requires an answer.
TIME, as some philosophers note, is a four letter word. The central issue here is the adequacy of management's loss estimates. Based on house prices declining another 10 to 15% and the defaults continuing at the current rate for 18 months, Jay Brown, CEO of MBIA, has said that they will not have to revise their 3/31/08 loss estimates if the crisis develops as projected. Tom Brown, at bankstocks.com, makes some interesting arguments to the effect that the housing crisis will be far less severe than most projections. Check it out. I have done some work, getting a look at the servicer reports for various books of mortgages insured by monolines, and I am encouraged by what I have seen through 5/25, my last report. If MBIA management is correct about losses, my trades will show a profit by the end of the year.
I am intrigued by the possiblity of buybacks, given how low share prices are compared to intrinsic values. There are also possiblities arising from the establishment of new triple A entities, capitalized with the funds that are no longer required to support triple A ratings at the old insurance companies. Ambac is optimistic about the possiblities of remediation on their portfolio, which I take to mean enforcing warranty and representations liability on the mortgage originators. The size of warranty and representations liablities on Countrywide's and Merill Lynch's balance sheets suggests these hopes may be realistic. Bear Stearns last financial statement was silent on the issue. MBIA is also planning to avail themselves of all rights and remedies in the event of any breaches of warranty or misrepresentations. Any of these possiblities could come to fruition before the end of the year.
My remaining problem with this position is Ackman's voodoo vendetta: I have not been able to come up with a suitable tactic to deal with it. Various rants on my blog, letters to authorities, and letters to the editor have availed me nothing. The internet is wonderful - after a careful search, I have located a Voodoo practitoner (in Haiti), who, for a small fee, will be employing his black arts against Ackman. It cost me 39.95, which I charged against my VISA card. Already I notice his hair is turning whiter...Target (TGT) is heading down...
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