| ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
 MBIA's crisis began in the dying days of 2007, when the subprime disaster slammed into the previously cloistered world of bond insurers. The bond insurers, or monolines -- so called because they're legally authorized to sell only financial guarantees -- suddenly realized they potentially faced billions of dollars in losses on claims for structured finance products. The ratings agencies, themselves criticized for failing to foresee the mortgage meltdown, began hiking capital requirements for monolines to retain their triple-A credit ratings -- necessary for writing new business. This triggered a feverish hunt for capital, a perilous effort in markets frozen in a credit crunch.
Before the crunch hit, the monolines were viewed as extremely safe, stable, if dull specialty insurers. That's no longer the case. Four of the major monolines -- MBIA Inc., Ambac Financial Group Inc., FGIC Corp. and Assured Guaranty Ltd. -- found themselves in roughly the same situation, some (like Assured) much better off, some worse. MBIA, the biggest of the monolines, insures a key piece of the roughly $2.5 trillion municipal bond market in the U.S. Ambac, No. 2 by insured portfolio, launched the industry in 1971. FGIC, No. 4 (behind Financial Security Assurance Holdings Ltd., which was not hit by these problems), had been sold by General Electric Co. in 2003 to insurer PMI Group Inc. and private investors Blackstone Group LP, Cypress Group LLC and CIVC Partners LP and had expanded beyond muni bonds into vehicles such as collateralized debt obligations. Assured Guaranty, smaller than the rest, focused on its reinsurance business. The crisis hit overseas as well. Controlling shareholders of France's Natixis SA announced in November 2007 that they would buy out the bank's bond insurer, CIFG Guaranty, for $1.5 billion. Armonk, N.Y.-based MBIA had the highest profile of the monolines, and its recapitalization and rescue make it a natural candidate for Deal of the Quarter. MBIA claims to be the first bond insurer to guarantee structured finance products -- the very thing that got the industry into trouble. The world's largest monoline with an insured portfolio of $678.6 billion in policies net of reinsurance, MBIA moved first to seek more capital. At the time, the monolines were coming under intense pressure from ratings agencies, politicians and regulators, not to say short sellers. State regulators were poised to take them over, and Congress was holding hearings, mostly because of the impact monoline downgrades might have on municipal bonds. The MBIA rescue was also significant because of the presence of New York private equity shop Warburg Pincus, which made key investments and helped pave the way for other buyout firms, such as TPG Capital and Corsair Capital LLC, to recapitalize another group of distressed firms -- the banks. MBIA would eventually raise about $2.6 billion in new capital to maintain its triple-A status. That target, says the firm's chief financial officer, Chuck Chaplin, shifted over time. "Both of the credit agencies were looking for us to maintain or enhance our capital position, which in part happens naturally, since we're not writing new structured finance business," he says. Unfortunately, MBIA had no time. Warburg Pincus provided an initial jolt of confidence in MBIA by investing $500 million in common equity on Dec. 10, just four days before Moody's Investors Service said it was "somewhat likely" the monoline could suffer a capital shortfall that would threaten the triple-A rating. The investment entailed a purchase of 16.1 million shares at $31 per share, giving Warburg an 11.3% stake and two board seats. As part of the deal, Warburg agreed to backstop a shareholder rights offering of up to $500 million in early 2008 and received warrants for another 16.1 million shares at a strike price of $40 each. MBIA's stock closed at $33 a share on Dec. 10, buoyed by the Warburg deal but not nearly enough to recover the more than 50% in value it had lost in the previous six months. And that bump didn't last. MBIA shed about half its value by the end of January as the crisis deepened again. And despite having raised a further $1 billion through a Jan. 16 surplus notes offering, Fitch Ratings on Feb. 5 placed MBIA on credit watch for a potential downgrade. With its initial investment under water, Warburg stepped up again. The rights offering was changed on Feb. 6 to a $750 million common stock offering, which Warburg backstopped. In exchange, Warburg received another 4 million warrants with a $16.20 strike price, with the strike price of its original warrants falling to $31 per share, from $40 per share. And the backstop was never used. The Feb. 7 equity offering was oversubscribed, with the final tally at $1.1 billion in new stock issued at $12.15 per share, a 15% discount to the previous day's closing price. Warburg tossed in $300 million, making it MBIA's largest shareholder with 18%. At the time, the transaction represented one of the largest private placements in a public company, though multibillion private equity investments in Seattle-based Washington Mutual Inc. and Cleveland's National City Corp. have since overshadowed it. Did it work? So far. MBIA has held on to its triple-A ratings with two of the three major agencies, Standard & Poor's and Moody's, and the capital helped it to fend off more difficulties after the Bear Stearns Cos. liquidity run in March. Its stock, however, continues to slip, falling 18% between the Feb. 13 announcement of the second capital infusion and the close on April 28. The new capital helped, but it's not a cure-all.
A dry recitation of MBIA's capital infusion doesn't do justice to the tensions, and to the psychological twists and turns, that prevailed from December through March. The credit markets continued to lag, and fears of recession mounted. The crisis seemed to shift to new targets and new instruments weekly as mortgage foreclosures mounted. There appeared to be no relief. MBIA's early jump on financing did prove key to its ability to secure further funds. "One of the smart things they did was they were one of the first to get out," says Mark Lane, an analyst with William Blair & Co. LLC. "They believed that when they needed to raise capital further down the road, it would give them credibility." Chaplin says MBIA began to analyze its exposures to housing in summer of 2007 -- just after subprime began to implode. They found some areas of concern, he says, and began a "what-if" analysis. The problematic areas involved MBIA's direct subprime wraps, subprime assets in CDOs and prime home equity loans and second mortgages, he says. "Because we had substantial exposure to that third bucket [home equity and second mortgages], we saw some concerning scenarios," he says. Based on the analysis, MBIA by November realized it needed to start what Chaplin calls "a serious capital campaign" to satisfy ratings agencies. "We thought it was important to raise as much capital as we could access and do it very quickly. As the market worsened, we didn't want to be crowded out." That produced the first Warburg investment, which included plans for the second shareholder rights offering. But the markets were deteriorating faster than MBIA initially anticipated, and pressures were increasing. One source of constant pressure was Pershing Square Capital Management LP's William Ackman, 41, who in November announced that he had pocketed serious profits shorting MBIA shares, which he would partially donate to charity. The irrepressible activist has notched some splashy victories in recent years, from blocking Eddie Lampert's bid to take out the minority holders of Sears Canada Inc. in early 2007 and forcing the early 2006 spinoff of Wendy's International Inc.'s Tim Hortons Inc. business. Following Warburg's first investment in MBIA, Ackman wrote to the Securities and Exchange Commission and the New York State Insurance Department calling Warburg Pincus' commitment "misleading" and claiming that it "overstated the probability of transaction consummation." In other words, in Ackman's view, MBIA was toast no matter what Warburg did. At the same time, says Chaplin, the ratings agencies were all over the monoline, demanding to review its book of business to make a new ratings decision. In February MBIA did manage to sell $1 billion in debt. Chaplin says that the company opted for a so-called surplus notes offering, a bondlike instrument available to insurers, because "it's much less expensive than raising equity capital but gets full equity treatment in the ratings agency capital models." Adds Nicholas Potter, a partner at MBIA's legal counsel Debevoise & Plimpton LLP, "Surplus notes don't dilute equity at the holding company, but from an insurance law point of view, it's like raising equity, except it's higher up in the capital structure." Nonetheless conditions worsened and the stock price sagged, taking a big bite from the value of Warburg's stake. MBIA then decided to change the planned rights offering to a straightforward share offering. "We wanted to do a transaction that was in and out of the market very quickly," says Chaplin, noting that a rights offering takes some 30 days to complete. A source familiar with Warburg's position says the decision was driven by fear of "being out in the public market for 30 days where they would have a quiet period and wouldn't be able to say anything while the shorts attacked. The equity offering took two days." Another consideration in volatile markets: flexibility. MBIA wanted to increase the offering if demand developed. No one really knew what was out there. "With a rights offering, you're locked in," says Chaplin. An oversubscription eventually developed, leading Igor Kirman, lead partner for Warburg's counsel on the deal, Wachtell, Lipton, Rosen & Katz, to declare, "The market spoke and validated the decision." Warburg Pincus faced its own set of grueling decisions. It refused to talk about the deal, but one source says the firm targeted monolines initially for several reasons. First, he says, because "bond insurers have no liquidity risks, unlike banks and mortgage companies. They're insurance companies, and they get paid up front." Second, Warburg liked MBIA's "huge embedded book of business" of some $6.3 billion in prebooked revenue. "So if they never write any more business, they could run that off and the value in that business would be higher than the value in the stock today," the source says. Third, a big part of Warburg's investments in financial services in recent years have been in "times of displacement." An example: the firm's $158 million investment in Mellon Bank Corp., which was amid a good bank-bad bank restructuring effort, in 1999. Warburg invested in the "good bank" and sold out at roughly 10 times the original value eight years later. Warburg shrugged off the initial hit to its first investment because, the source says, it normally invests over four to seven years. While he could not cite targeted returns, he says Warburg's "principal is fully protected on the downside and expects very attractive private equity returns in the base case." But once it made that investment, Warburg faced the classic gambler's decision: Raise or fold. If the firm failed to raise its bet on MBIA by guaranteeing the backstop, the second offering might have collapsed and Warburg might have risked losing its entire investment. Instead, Warburg crawled further out on the limb. "Common equity is the last in line to collect, after bondholders, creditors and preferred holders are paid off, if a company goes bankrupt," Kirman says. Warburg even agreed to strip out standard closing conditions on material adverse changes and representations and warranties between the two parties to demonstrate its confidence. Says Potter, "Given the fact the deal had to sit out for some period of time [to await regulatory approvals], they [MBIA] had to make the ratings agencies happy that the capital would come in." Warburg agreed to removing closing conditions on the first day of talks, recognizing that it would be a "hell-or-high-water transaction," Potter says. Warburg and MBIA's gutsy play worked. MBIA sold $750 million in equity, and the buyout shop got a larger position. The cost basis of Warburg's $800 million investment is an average price per share of $19.60, the source says. Taking the additional 25 million warrants into account, with a value of $4 to $12 per share, a conservative estimate of the cost falls to $15.20 per share. "The value is now below where Warburg was, and they have plenty of time for the upside," says the source.
It turned out Warburg Pincus wasn't the only investor eyeing the monolines. Berkshire Hathaway Inc.'s Warren Buffett in a Feb. 11 CNBC interview offered to reinsure $800 billion in municipal bonds covered by MBIA, Ambac and FGIC, which could have freed up $8 billion of regulatory and ratings capital. All three rebuffed his offer to buy their muni books. And master of distress Wilbur Ross of WL Ross & Co. LLC agreed on Feb. 29 to invest up to $1 billion in Assured Guaranty. Ross targeted the relatively healthy monoline to expand its reinsurance business, which he believes will be in great demand from its ailing peers. Now that the final capitalization round has been completed, the question remains whether $2.6 billion in new capital can protect MBIA from a deluge of mortgage-related losses in the next few years. "At this point, the ratings agencies indicate it's enough, the company feels it's enough, but investors seem to be betting it's not enough," says Piper Jaffray & Co. analyst Mike Grasher. "In my opinion, we'll find out over the next six to nine months if it'll be enough." Grasher estimates the monoline has about $21.5 billion in mortgage-related exposures, with $11 billion in home equity and the rest in closed-end second mortgages. Nearly 80% of the $21.5 billion in loans was originated in 2006 and 2007, and based on an 18- to 36-month lag, the bulk of delinquencies should surface between mid-2008 and mid-2009. Grasher expects MBIA to log about $3.5 billion in structured finance losses over the next 15 months, which includes a $736 million loss in the fourth quarter ended Dec. 31. Chaplin says that at the end of 2007, MBIA anticipated about $1 billion of losses from its CDOs and second mortgage portfolios, adding that the firm will update those figures in its next 10-Q. He says roughly $815 million in second-mortgage and home equity line-related claims should be paid out within two to five years and the rest related to CDOs should start in 2009 and be paid out over the next "few" years. Still, MBIA is not clear yet. The capital increases provided MBIA with more than $17 billion in total claims-paying resources and won that essential triple-A rating with two of the three major ratings agencies -- Moody's and Standard & Poor's. Fitch on April 4 downgraded MBIA's insurer financial strength credit rating to double A, arguing that MBIA would need a further $3.4 billion to $3.8 billion in new capital to maintain the triple A. This followed a request in March from MBIA that the agency withdraw its IFS rating. "Fitch does not have enough information on our portfolio to do a cogent analysis," Chaplin insists. "Fitch only rates about 30% of our transactions, versus 85% at Moody's and S&P." Chaplin says, "The $2.6 billion enabled us to earn affirmations of S&P and Moody's in February and puts us in a position to rebuild and regain the competitive position we enjoyed in the past." The company, he says, is starting to "rebuild the flow" of its muni business.
With a bigger capital cushion, MBIA's next step is to restructure by splitting its muni and structured finance books. Who better to lay out the split-book plan than returning chairman and CEO Jay Brown, who left the monoline just before last summer's subprime meltdown. Brown, chairman and CEO of the monoline from 1999 to 2004 and executive chairman until his brief retirement, returned on Feb. 19 following Gary Dunton's resignation. Less than a week after his return, Brown outlined a five-year split-book plan, as well as a six-month halt on new structured finance business and a replacement of the quarterly dividend with an annual dividend that would save $174 million annually. However, Brown's plan to sever MBIA's low-risk muni business from its riskier structured finance book met opposition from MBIA's biggest critic, Ackman. The activist argued in a Feb. 14 congressional hearing on bond insurers that the goal should be to protect the solvency of the muni business, which, he said, could be best done through his own version of a split-book plan. Ackman's plan would make the muni unit a subsidiary of structured finance. As the parent, structured finance would collect dividends and sell some or all of its stake in the muni business to raise capital. Brown argued that Ackman's plan would choke off the holding company by cutting dividend flow. As rival FGIC raced to develop its own split-book solution -- earlier this year it made a request to the New York State Insurance Department, allowing it to pursue this type of restructuring -- newly capitalized MBIA has chosen a five-year strategy. "There are a number of hoops they have to jump through," says the source. "They have to get the ratings agencies comfortable with it, and depending upon the ratings agencies' response, my sense is they would need more capital if the books are split." While protecting the muni business, a split-book plan may offer "less diversification of risk," he says. "But it's not in the best interest of MBIA now to raise more capital. If they wait for the market to normalize, they'll have excess capital and then they'll split the books." As a result, MBIA's capital enhancement strategy is far from complete. Chaplin says the company is now seeking less dilutive ways to improve its capital position, such as reinsurance solutions. First ensure with capital, next reinsure. - Michael Rudnick
Categories Deal Video
    Community
 Elsewhere on The Deal.comDealwatchThe Deal MagazineCorporate Dealmaker
The Deal VideoCategories
Blog roll
Archives
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
