Thursday, February 21, 2008

Ackman and MBIA Inc.

William Ackman, of Pershing Square Capital Management, has brought the act of monoline insurance bashing to new heights, elevating it to that of an Olympic sport. He has been all over the news the last few months, talking his book up, or down in this case. So I decided to go through his bear case thesis line by line to see if he in fact knows what he is talking about, or is he just trying to scare fellow investors out of the stocks he is shorting.

His case is made up of several arguments. I will attempt to analyze each one of them down to its simplest form, since insurance is well known for the density of its financials. I am using the data from the 149-page massif that he posted on his web site, dated November 20, 2007, and I am focusing on MBIA Insurance. I was inspired to look into this matter after I heard Marty Whitman of the Third Avenue Value Fund dismiss Ackman with the simple phrase “he doesn’t understand insurance.” There’s no better sport to watch than a battle of the “smart money.”

Ackman has made many claims:

1) The holding company will be insolvent by the second quarter of 2008.

2) Channel Re, a captive reinsurer that is 17% owned by MBIA, and that reinsures $43 billion in exposure is not an adequate backstop and these exposures will be brought back into MBIA.

3) MBIA has a "GIC business" which invests money held by municipals received from bond issuance. They invest that money for municipalities and pay a fixed fee to the municipalities. MBIA is restricted to AA or better investments but the spread earned implies they are taking too much risk.

4) MBIA is understating its losses by using a mark to model rather than a mark to market system.

5) MBIA's investment portfolio has more risk than it seems because the company owns triple AAA bonds that are insured by itself.

6) MBIA raises money to fund itself through an SIV called Global Funding and the company is having difficulty finding buyers for the medium term note paper that this entity issues.

Claim #1

Ackman states that the holding company will be insolvent by the second quarter of 2008.

A little background first. MBIA Inc. is a holding company that is a publicly traded entity under the symbol MBI. The holding company owns an insurance subsidiary called MBIA Insurance Corporation. The holding company has no actual operating businesses. It receives income in the form of dividends from the insurance subsidiary, and another business that is involved in investment management. The dividends paid are subject to approval by the New York State Insurance Department, which is responsible for regulating the insurance entity.

Ackman uses a cash balance as of 9/30/07 (slide 125) of $464 million and states that MBIA will be insolvent in somewhere between 2.2 and 4.9 quarters. This has already been proven incorrect as the company ended the year with a balance of $434 million at the holding company level (MBIA conf call 1/31/2008). His predicted cash burn of $95.4 million turned out to be only $30 million. Now in his defense, he did put a disclaimer in there that if MBIA raised more capital then the insolvency would be postponed. However, this capital was downstreamed to the insurance subsidiary so it is not clear how this capital would help the holding company except to the extent that it makes the insurance subsidiary stronger.

Ackman also states that MBIA won’t be able to access its credit line if it takes a writedown in excess of $2.4 billion (slide 126) since it will be in violation of its covenants. This was also proven incorrect as the credit line is intact and available as of the end of January (MBIA conference call 1/31/08). Of course the capital infusion helped here as well.

Furthermore, the cash flows that the holding company could expect in 2008 include the statutorily permitted insurance company dividend and the net income of the asset management business if MBIA decided to stop growing the asset liability management business. That total would be $639 million. (MBIA conference call 1/31/2008)

Perhaps this is why Ackman is so desperately lobbying the New York State Insurance Department to restrict payment of the dividend to the holding company. Also, keep in mind that the holding company pays a discretionary dividend to shareholders and did pay $43 million out to shareholders in January 2008. It could also cut this back if needed to save money.

According to MBIA at its conference call on 1/31/2008, the holding company has $1.2 billion in debt. Two issues are due in the next three years - $143 million in 2010 and $100 million in 2011. Interest expenses on the debt are $80 million a year, and other miscellaneous expenses of the holding company bring the yearly expenses to $250 million.

It does not seem that a liquidity crisis is at hand for the holding company.

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