Sunday, June 29, 2008

Whitney Tilson on MBIA

There is a great Whitney Tilson post on MBIA on Seeking Alpha.

To me the key difference between the AA guarantors and the AAA guarantors was that by-and-large the new players in this industry (such as ACA Capital Holdings) had to post lots of collateral in the event of problems - accelerating liquidity concerns and hence bankruptcy. The AAA guarantors by-and-large had to pay when the liability fell due.

This is a huge difference. I have argued several times (see here and here) that the price of various bits of paper in the secondary market is irrational. However I have no idea what the rational price is. Nor does anyone else - not the shorts, not the longs - not anyone.

If you have to mark to market the books of financial institutions they are almost all insolvent. There is an enormous amount of paper that is 20 bid, 90 offered, price you could actually get something closer to 20. If you have to collateralise based on actual values you could get in a trade now (or sell illiquid assets to buy liquid ones for use as eligible collateral) you are stuffed. Simply stuffed.

But if you can sit it out then you are possibly OK. The reason - the defaults might be much lower than currently anticipated in market pricing. Regular readers will know my view is that defaults will be lower than current market prices. I just don't know how much lower and hence I don't know what the end-game is for someone who is levered to this stuff but does not need to post collateral.

ACA Capital Holdings had contracts that demanded it posted collateral and that smashed them up - simply smashed them. Their website is indicative of what happened to the company. But the case for Ambac and MBIA was that by-and-large they did not have to post collateral and hence had hope.

However we now know that MBIA in particular has large collateral requirements. I know of a few more contracts that potentially involve collateral at MBIA. Cumulatively they matter a great deal.

If you are thinking about the bond insurers as a buy (and I am) the collateral requirements are the critical issue. If you don't have collateral requirements then the end points are all that matter. If the things you have insured default at a (much) lower rate than the market currently thinks (something that is possible) then you will make money.

For now you have the hope of much lower end-point defaults. Hope means the stocks have value. Option value only - but as the end outcome is a long way away and a lot of things can happen there should be quite a lot of option value. [One possibility for instance - there is a lot of inflation over say ten years which reduces the real value of the liabilities or increases the nominal value of the assets that back them. That could be a blessing to a bond insurer.]

If you have collateral requirements then end-point solvency is not all that matters. You need to be continuously solvent and on current market prices you are not solvent right now. Whitney Tilson's article is the first widely available and easy to follow discussion of the collateral requirements of MBIA. And this is the critical issue for the stock. Read it.

Now please please contact me if you have done a similar run through Ambac. I have not - but I knew of far less that was collateralised at Ambac than MBIA. And that matters. It's why I sometimes think I want to punt on Ambac. [Indeed I have at various times - but have hedged the position shorting Ambac debt and made good profits by sheer luck. Those were not super speculative positions. Buying Ambac common without shorting the debt is a massively speculative position.]


A note - the saga of MBIA saying for years that they had few collateral requirements and then revealing billions of dollars worth of them tells you about trusting management. I can't just ring up Ambac management and ask them about collateral requirements. If you had done that with MBIA you got creamed.

Indeed some very fine fund managers got creamed doing precisely that.

Ronald Regan was right: "trust but verify".


Post script: I do not agree with everything that Whitney Tilson writes in his Seeking Alpha article. I strongly disagree with his assertion that MBIA has an obligation to downstream the $900 million sitting in the parent company. The buyers of guarantees from MBIA purchased them backed by stated regulatory assets of MBIA's insurance subsidiary not the MBIA parent company. I see no reason why MBIA parent company should increase those regulatory assets unless they are contractually obliged to do so.

Of course Whitney (talking his book) has a different view. I have a suggestion: next time Whitney invests in a stock that goes to zero he should pour more of his clients' money in just to make the creditors happy. (He argues that MBIA should do this with shareholder capital and its insurance subsidiary). If Whitney acts as irrationally as he is demanding the management of MBIA act then I am sure the creditors of his bankrupt investment would thank him.

For once - and perhaps the first time - I find myself strongly agreeing with Tom Brown of [I can't tell you how many times I have thought Tom is speaking nonsense.]

1 comment:

Huntington Hartford said...

I saw Whitney give a 2 hour presentation on MBIA at a CFA lunch. I was impressed with his speech and I'm glad I took his advice.

He did what I would call a "bottom's up" analysis of some of that low priced, "20 bid, 90 offered" paper that, like you say, is still highly rated paper. He tried to show that the shockingly low, irrational market price could be justified without making pessimistic assumptions, just by looking at individual tranches performance... unraveling the securities. I thought he did a good job but I'm no expert in this area.

I then talked to a young bond guru who specializes in these securitizations. I wanted to get the other side of the story on the valuations. From what he explained to me, the defaults suffered at the beginning of the securities' life is too extreme and, unlike past models would indicate, their assumptions for the future are not valid. I'm not saying this the right way but basically they used to project the defaults one way, now they're changing that because of the extreme nature of the initial defaults. It sounded like "our model was broken before, now it's right". Whitney's case was using the old model. I walked away feeling nobody can possibly know what these securities are worth.

The basic premise that you can take a BBB rated bond, pay an insurer a premium (something less than the spread between a BBB and an AAA), and then it magically becomes an AAA rated bond is fundamentally not right. Maybe you can get away with this once or twice but if you do it enough, you're saying market pricing is invalid. MBIA did it a LOT, that was their actual business.

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