The Wall Street Journal-20080201-Bond Insurer-s Woes Add To Credit-Market Stress- MBIA Posts Huge Loss On Bad Subprime Bets- Investors See Rebound
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Bond Insurer's Woes Add To Credit-Market Stress; MBIA Posts Huge Loss On Bad Subprime Bets; Investors See Rebound
Full Text (1715 words)MBIA Inc. made a name for itself in a sleepy but reliably profitable business -- insuring against defaults on bonds issued by cities and states. The bonds almost never went bad, and even when they did, the losses were minimal.
But growth was sluggish, so MBIA ventured into a hot business that appeared to be more lucrative. It began insuring complex securities backed by home mortgages.
Yesterday, the move came back to bite it. MBIA reported a $2.3 billion loss for the fourth quarter, due mainly to declines in values of securities it insures. It said it incurred losses of $714 million on securities backed by mortgages. That's nearly as much as it's paid out in claims over its entire 36-year history -- $920 million.
Things could get worse. Mortgage defaults are rising, home prices are falling, and rating agencies are predicting that losses on investments tied to mortgages will be far worse than believed a few months ago. Standard & Poor's said Wednesday such losses could top $265 billion. That's bad news for MBIA and its rivals, which include Ambac Financial Group Inc., Financial Guaranty Insurance Co. and Financial Security Assurance Inc.
The fate of these insurers is shaping up as a crucial chapter in the unfolding financial crisis triggered by the popping of the U.S. housing market.
These little-known firms are vital links in today's complex global financial system, guaranteeing payments on more than $2 trillion of securities. Such insurance enables everyone from governments to corporations to raise capital more cheaply. And the bond insurers' woes could drag down the value of the securities they back -- potentially saddling Wall Street firms with tens of billions of dollars in additional losses. The New York State Insurance Department recently hired Wall Street firm Perella Weinberg Partners LP to explore a possible rescue plan for bond insurers.
"I'll be the first one to admit that we got sucker-punched, but we are not alone," said Gary Dunton, MBIA's chief executive officer, in an interview two weeks ago. Company officials said they didn't anticipate how widespread the mortgage problems would become.
Yesterday, in a conference call to discuss the earnings, he turned to a grimmer earthquake analogy. "A few of our underwriting decisions from the past couple of years have tested the Richter scale," he said.
In the conference call, MBIA executives assured investors that the company's finances were sound, and that it was working to keep its stellar credit rating. That caused its shares to rise by about 11% to $15.50 in 4 p.m. composite trading on the New York Stock Exchange, although they remain almost 80% below their highs from a year ago. The news also lifted the overall market, which has been skittish about the widening fallout from the subprime-lending mess.
Notwithstanding the company's optimism, S&P yesterday said it was considering lowering MBIA's top-notch credit rating. Moody's Investors Service is already considering such a move, which would make it difficult for the company to insure most new bonds.
Such a downgrade would have broad implications for Wall Street, because it would result in lower credit ratings for the bonds that MBIA itself insures. By some estimates, insurer downgrades could lead to between $40 billion and $70 billion worth of write-downs on Wall Street, which has already suffered more than $100 billion in losses tied to subprime mortgages.
MBIA began ramping up its structured-finance business in the 1990s. Bond insurers assumed that losses on securities backed by mortgages wouldn't be much higher than losses on municipal bonds. In 1998, it bought CapMAC Holdings Inc., a New York firm that specialized in insuring asset-backed securities. That gave MBIA a team of experts and access to potential customers.
During the boom years that followed, MBIA and the credit-ratings firms saw the world in much the same way. Housing-related assets were considered relatively safe because defaults were low. Wall Street firms had figured out ways to slice and dice mortgage pools so that most mortgage bonds carried top-notch investment ratings.
In the first half of 2007, evidence began trickling out around the nation of rising mortgage defaults. Executives at MBIA's headquarters in Armonk, N.Y., soon started noticing deterioration in the performance of some of the mortgage-related bonds it insured, according to Mr. Dunton, the chief executive.
Executives pored over the details of the mortgage portfolios. What they found was alarming. "A modest tremor in the residential mortgage markets by November erupted into a full-blown seismic upheaval," Mr. Dunton said on yesterday's conference call.
The company's priority was to retain its high credit rating. In the lobby of its headquarters, there is a large picture of sunlight shining through trees. It carries a description of the company's business: "We help our clients achieve their financial goals by providing Triple-A credit protection."
But analysts at rating agencies also had noticed the rising mortgage delinquencies. At Moody's, a team of analysts led by Jack Dorer started growing concerned about insurers' exposure to mortgages.
In deciding what credit ratings to assign insurers, Mr. Dorer focused on a mix of criteria, including balance-sheet strength, market share and profitability. He also factored in Moody's ratings on collateralized debt obligations, the complex debt securities that MBIA had become a player in. As the subprime-mortgage crisis intensified, the ratings on these CDOs were under pressure.
By last fall, Moody's had downgraded more than 1,000 subprime- mortgage bonds. Nevertheless, Mr. Dorer's group said it didn't see any serious problems for insurers unless the situation deteriorated further. "MBIA's portfolio quality is strong," Moody's said in an Oct. 5 note.
But the problems were worsening. On Oct. 11, Moody's slashed ratings on more than 2,000 additional subprime-mortgage bonds. Mr. Dorer's group began meeting more often with Moody's mortgage analysts to ascertain the impact on the bond insurers.
In November, as the mortgage market continued to deteriorate, rating agencies grew more worried. Moody's and S&P were reassessing the ratings of bond insurers.
Back at MBIA, it was dawning on top executives that they would need to raise more capital to secure against the rising possibility of losses on the bonds. In mid-November, Chief Financial Officer Chuck Chaplin discussed the issue for the first time with Mr. Dunton, Mr. Chaplin recalled in an interview. Initially, the company thought it would need perhaps $1 billion to $1.5 billion, but the number ultimately grew to more than $2 billion, says Mr. Dunton. At one point, he thought MBIA might be able to use any excess capital raised to buy a distressed rival.
MBIA hired bankers at Lazard Ltd. to help raise the money. By late November, MBIA was working in "hyperdrive" with private-equity firm Warburg Pincus LLC, according to Mr. Chaplin.
But as conditions in the mortgage market continued to worsen, Moody's was becoming more concerned. On Dec. 4, it announced it had slashed the ratings on more than 1,000 mortgage-related bonds. That caused Mr. Dorer's group to take a more pessimistic view of the mortgage assets on the books of MBIA and other insurers.
The next day, Mr. Dorer and his colleague, Stanislas Rouyer, published new concerns about MBIA's capital position, saying it was worse than previously thought. MBIA shares slid 16% on the news. On Dec. 10, MBIA announced it had raised $1 billion from Warburg Pincus, which it viewed as a victory because some of its peers were also seeking such financing.
Nevertheless, on Dec. 14, Moody's put MBIA on "negative outlook," the first step in considering a downgrade, jolting executives in Armonk who thought they had bought some time with the Warburg deal.
Mr. Dorer and his Moody's team were changing their minds about MBIA's situation, their published reports indicate. The company, they concluded, had slipped from one of the better positioned insurers to the middle of the problem, in large part because of its holdings of risky CDOs that held subprime mortgages.
Mr. Dorer says MBIA had increased its portfolio for much of 2007, just in time for the mortgage downturn. As far back as the summer, he says, "it became apparent that these were exposures that could have some significant volatility."
By the end of the year, Mr. Dorer and his team were delivering bad news to MBIA in near-daily calls. In mid-January, Moody's put MBIA on "review" for a downgrade, the next step in considering such a move. In a downbeat note, Moody's predicted the business of bond insurers could be damaged for years.
These are "unprecedented market conditions," says Mr. Dorer, who started following MBIA and other bond insurers in 1998.
Moody's decision "caught us a bit by surprise," says MBIA's chief financial officer, Mr. Chaplin. He adds that he expects the company's credit outlook to return to "stable" in the future.
On yesterday's conference call, MBIA executives lashed out at critics of the company, calling them "adversaries" trying to take the firm down.
Hedge-fund manager Bill Ackman has been betting against MBIA's shares for years. In November 2002, when he was about to publish a report arguing that MBIA's credit rating was too high, he met with Joseph Brown, then MBIA's chief executive. Mr. Ackman says Mr. Brown warned him to "think very carefully" before publishing it, which Mr. Ackman says he perceived as a threat. Mr. Brown says he didn't intend to threaten him. He recalls that he refused to shake Mr. Ackman's hand.
Mr. Ackman published the report anyway, and contacted Wall Street analysts, other hedge funds, journalists and rating agencies to give his views on MBIA. Moody's Mr. Dorer and his colleagues met with Mr. Ackman about half a dozen times, mostly in 2006 and 2007. They weren't persuaded by Mr. Ackman's argument, according to one person involved in the meetings. In recent months, Mr. Ackman has intensified his public attacks against the bond insurers.
The fate of the bond insurers has big ramifications for other corners of the financial markets. Worries about whether insurers will be able to make good on their bond guarantees has begun to dampen demand for municipal bonds. That has already increased the cost of borrowing money to fund public projects.
S&P said yesterday that the $1.5 billion in capital MBIA has already raised is not enough, and that it needed to move quickly on plans to raise more. "Time is of the essence," it wrote.
