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MBIA (MBI)
How a Split at MBIA Could Save the Company and Ruin the Economy
While investment banks have certainly taken a number of broadsides from the subprime mortgage market, Armonk, NY-based bond insurer MBIA's hits may mean a lot more to investors. While the likes of Citigroup (C: Charts, News, Offers) and Merrill Lynch (MER: Charts, News, Offers) have had to write down billions of dollars in debt, the odds of them going under and hurting the economy are not nearly as great. With $673 billion in bonds insured, a downturn or bankruptcy at MBIA would undoubtedly send the economy straight into a recession. Shares have plummeted more than 80% since October, and a turnaround is not likely to come soon. How will the company stay afloat, and what is the prognosis for the rest of the bond insuring industry?
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Last week Warren Buffett, the Oracle of Omaha, opted to begin his foray into the bond insurance debacle by creating a bond insurance company to "help" insure municipal bonds. The new company would have an oft-coveted AAA rating, and would assume the risk of bonds guaranteed by MBIA and two of its rivals, Ambac and FGIC. The value of insurance comes in at a cool $800 billion, but savvy investors immediately cut through the smoke and haze surrounding the deal: Buffett isn't guaranteeing all municipal bond insurance, only the top tranche. Bonds are often broken up into tranches based on risk, and these chunks are securitized and sold off as derivatives. Buffett only wants to insure the most risk-free of the bonds, so bond insurers will still be on the hook for the more troubled types. Warren Buffett, by investing roughly $5 billion, would now control roughly 30% of the municipal bond insurance market.
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Does MBIA benefit at all from the deal? Maybe. Bond insurers have found themselves in quite a pickle since 2007, what with rising defaults and liquidity problems and all. The municipal bond market is worth well above $2.5 trillion, and MBIA is probably not in the position to actually perform the function that it claims to perform: serving as a sort of last resort when bond payments are really needed. The company is dubbed "monoline" because it provides bond insurance to only one type of industry. The cash infusion offered by Buffett allows monoline companies to keep their coveted credit ratings (AAA), which keeps borrowing costs low and the value of the paper they guarantee high. The main problem is that MBIA will still have to deal with its exposure to subprime loans. Back in the 1970s MBIA et al. stuck to guaranteeing municipal bonds, and all was well. Once the advent of securitization and structured products hit the mainstream the company was more than happy to guarantee the payments of riskier debts because the fees received from the guarantees were substantial. The company was helping create the sort of products whose names now cause many investors to head to the hills: collateralized debt obligations and asset-backed securities.
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When things started to head south last summer it became clear that rising defaults could hurt the company's credit rating. As the rating falls the company would be forced to put up more assets as collateral, and the amount of the collateral increase could cause it to run out of assets. A rating decline would also lower the rating on the municipal bonds in its portfolio, and with MBIA putting its seal of approval on roughly $670 billion dollars of municipal debt the increased cost of borrowing associated with a rating cut would hammer bond issuers. By guaranteeing bonds with values far beyond their capabilities, MBIA and its competitors would be unable to actually serve as an effective backstop. Essentially, MBIA might not be able to really put its money where its mouth is. Some estimates place MBIA's leverage at roughly 150 times the amount of capital it has on hand.
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So what does MBIA do? Its obligations aren't going to just up and go away, so executives have been toying around with the idea of splitting its business into separate units. The company's CEO, Jay Brown, indicated that the primary goal is to separate MBIA's traditional municipal bond guarantees from the asset-back securities that it has helped issue. The idea harkens back to the good old days when MBIA didn't toy around as much with CDOs, but splitting the business could be costly and would most likely slow down growth. Because this idea is somewhat radical, MBIA opted to quit its membership in the Association of Financial Guaranty Insurers. A split up of MBIA could very well ruin a number of banks. While Brown's idea of splitting the guaranteeing of municipal debt from debt associated with subprime mortgages would make investors happy, it will likely cause a lot of problems for other companies. A split will certainly help the municipal unit, but if MBIA creates a separate entity for subprime debt this entity is more likely to go bankrupt or see a ratings downgrade, which in turn will ruin the multitude of banks that hold onto this seemingly "bad" debt.
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