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Thomas Shyr

Michael Francis

MBIA, Inc., (NYSE: MBI) is the world's largest bond insurer, and a financial guarantee and investment management company. It operates as a monoline insurer earning revenues by charging fees for investment management services and by insuring securitized debt. MBIA guarantees that if a bond fails, it will cover the interest and the principal amount.

MBIA also insured collateralized debt obligations (CDO) such as mortgage backed securities (MBS). While these insurance policies were lucrative, and MBIA's revenues rose 140% between 2001 and 2006^[1], MBIA underestimated the probability of defaults and undervalued its insurance policies. Since the onset of the 2007 credit crunch and financial crisis in 2008, MBIA was obligated to cover large numbers of failed mortgage backed securities. Beginning in April of 2008, MBIA's credit rating began to deteriorate, as it lost its AAA rating.^[2] On February 18 2009, MBIA's credit rating was rated B3, or below investment grade.^[3] On September 28, 2009, S&P rating agency cut the main bond insurance unit to noninvestment grade, or junk bond status.^[4]

In response to large losses and difficulty attracting new business due to lower credit ratings, MBIA separated its municipal bond unit into a new operation called National Public Finance Guarantee Corp.^[5] By separating the more stable municipal bond division from troubled assets, MBIA hopes to attract new business. However, this move has come under harsh scrutiny, as large banks, including Bank of America (BAC), J P Morgan Chase (JPM), Barclays (BCS), and Citigroup (C) have sued MBIA over the restructuring.^[6] They charge that by shifting $5 billion of MBIA's assets out of a key unit and into the new division, they effectively left the original unit insolvent, or unable to meet claims.^[7]

For the third quarter of 2009, MBIA posted a net loss of $728 million as the U.S. housing market continues to struggle.^[8] MBIA attributes the loss to an increase in net claims it paid out and an increase of losses on credit derivatives MBIA had insured.^[8]

Company Overview

MBIA, headquartered in New York City, generates revenue by providing financial guarantee insurance and investment management services. Financial guarantee policies are typically written on bonds such as municipal bonds and other asset backed securities (ABS), protecting the holders against default. It also collects interest on its own investments by reinvesting its float.

In February of 2009, MBIA announced it would be restructuring its business in response to continuing turmoil in the markets.^[9] Within this plan, the goal is to create separate entities for its public finance, structured finance, international financial guarantee, and asset management segments. By seperating each business segment, MBIA hopes to attain a higher credit rating in each stand alone business, thus helping the company as a whole.^[9]

Business and Financial Metrics

In 2008, MBIA had a net loss of $2.7 billion USD, an increase from its 2007 net loss of $1.9 billion USD.^[10] Revenue decreased to a loss of $857 million in 2008 from its 2008 revenue loss of $284 million.^[11] Revenues from insurance business increased $1.57 billion, largely stemming from a $1.4 billion reduction of losses on insured derivatives, while its investment management services revenue declined $2.17 billion in 2008 due to losses on Securities they sold.^[11] Between 2007 and 2008, MBIA's expenses rose 3% from $2.8 billion in 2007 to $2.9 billion in 2008, mainly because of continued losses related to its insurance business.^[12] Despite losses throughout 2007 and 2008, MBIA turned a profit during the first quarter of 2009 of $701.0 million, helped by a $1.6 billion accounting gain.^[13]

Revenue and Net Income were negative for 2007 and 2008 after strong years in 2005 and 2006.^[14]

Breakdown of MBIA's 2008 revenue losses (gains are shown as negative values).^[14]

Business Segments

MBIA breaks its operations into three segments: i) Insurance, ii) Investment Management, and iii) Corporate operations.

Financial Guarantee Insurance (65.3% of 2008 revenue loss)^[11]

MBIA's insurance segment insures a wide range of securities, ranging from municipal bonds to mortgage backed securities (MBS) to utility bonds. Total Revenue from MBIA's insurance operations was a loss of $534 million, a decrease from its 2007 loss of $2.1 billion.^[16] The decrease in loss was largely due to a $1.4 billion reduction in losses from its insured derivatives, as well as a $140 million increase in premiums.^[16]

Investment Management Services (42.2% of 2008 revenue loss)^[11]

MBIA breaks its investment management segment into three subgroups: i) asset/liability management, ii) advisory services, and iii) conduits. MBIA's investment management segment provides a range of products and services to the public, private, and financial services sectors. Services provided include cash management, asset management, commercial paper programs, among others.^[17] In 2008. revenues for its investment management operations as a whole were a loss of $345 million compared with revenues of $1.8 billion in 2007.^[18] Its 2008 asset/liability had a pretax loss of $1.4 billion, a drop from its 2007 pretax income of $294 million.^[19] The loss in 2008 was a result of a $1.7 billion loss on realized losses when it sold investment securities.^[20] Advisory service income decreased 18% to $15 million in 2008, compared to its 2007 level of $18 million, due primarily to a $5 million write down, and its assets under management (AUM) declining from $37.3 billion in 2007 to $34.6 billion in 2008.^[21] Its conduits segment reported a pretax loss of $6 million in 2008, a decline from its 2007 pretax income of $1 million.^[21]

Corporate Operations(-7.5% of 2008 revenue loss (gain))^[11]

The Corporate Operations segment primarily consists of holding company activities, and as such, it has little or no activity.^[22] Net Income for corporate operations in 2008 were a loss of $45 million, a decline from its 2007 loss of $93 million.^[22]

Key Trends and Forces

Litigation Surrounding National Public Finance Corp.

MBIA separated its municipal bond unit into a new operation called National Public Finance Guarantee Corp. in an effort to separate the more stable Municipal Bond division from the troubled assets of the rest of the insurance division.^[5] The general idea is to put all the "good" bonds into a separate entity so that it can achieve a high credit rating and therefore attract new business. While MBIA has been partially successful, as the National Public Finance Corp has received an 'A' rating from S&P Rating Agency^[4] this move has brought lawsuits from majoy banks, including Bank of America (BAC), J P Morgan Chase (JPM), Barclays (BCS), and Citigroup (C).^[6] They contend that by shifting $5 billion of MBIA's assets out of a key unit and into the new division, they effectively left the original unit insolvent, or unable to meet claims.^[7] Whether MBIA successfully defends this lawsuit may determine whether the new division is permitted to persist and attract new business.

Credit Spreads

The spread between the interest rates on credit instruments insured by MBIA and the risk-free rate is a major driver affecting the premiums earned by the company. Wider spreads mean larger premiums and generally higher margins, whereas narrow spreads decrease premiums. Spreads on most credit securities and derivatives have generally become wider in 2008^[23], leading to two offsetting trends for MBIA. First, wider spreads indicate that it becomes more likely to incur losses on securities insured when spreads were lower. This can be potentially offset by making future business more attractive due to higher premiums. However, because its fallen credit ratings, MBIA has difficulty offsetting these losses with new business, as low credit ratings not only decrease consumer confidence, but also raises its cost of underwriting policies.

Credit Ratings

MBIA's business model is largely dependent upon its overall credit rating. Credit ratings provide objective judgments about the insurer’s ability to pay insured parties when necessary, and declines in the credit quality of the company will cause its potential customer pool to shrink. MBIA receives insurance premiums by guaranteeing the coupon and principal of bonds. This premium is almost entirely based on MBIA's financial strength. Since April 2008, when MBIA first lost its AAA rating^[2], its credit rating has been downgraded to B3, which is below investment grade.^[3]

Alternative Products

MBIA faces the threat of competition from alternative credit enhancement products like credit default swaps, which have become much more widely available and liquid in recent years. There are very few barriers to entry in this business, since it is merely a counterparty agreement to pay in the event of default. Therefore, numerous banks and financial services companies provide these competing products.

Competition

The guarantor/financial insurance business is highly competitive. The only major barrier to entry that deters smaller financial entities from entering the market is a minimum capital requirement necessary to maintain a strong credit rating. Companies mainly compete on a mix of price and consumer trust as well as judgment of the insurer’s ability to pay. MBIA also competes with alternative forms of insurance, including derivative contracts such as credit default swaps, which are written by most major bank and financial institutions. This makes the credit insurance business substantially larger and more competitive. MBIA is a financial guarantor insurance giant, and competes directly against large bond insurers, most notably Ambac Financial Group (ABK).

• Ambac Financial Group (ABK), headquartered in New York City, is the second largest bond insurer in the United States with over $524 billion of debt insured.^[24] Like MBIA, Ambac has begun implementing a restructuring plan aimed at bringing in new business.^[25] In 2008, Ambac had total revenues of -$2.75 billion and a net loss of $5.61 billion.^[14]

Footnotes

1. ↑ MBI 10-K 2008 Item 6 Pg. 31
2. ↑ ^{2.0 2.1} MBIA Loses AAA Insurer Rating From Fitch Over Capital. Christine Richard. Bloomberg.
3. ↑ ^{3.0 3.1} Moody's downgrades MBIA Insurance Corp to B3. Moody's Investors Service.
4. ↑ ^{4.0 4.1} Alistair Barr. S&P cuts MBIA bond-insurance unit to junk. MarketWatch.
5. ↑ ^{5.0 5.1} MBIA shifts bond insurance business to new company. Bloomberg.
6. ↑ ^{6.0 6.1} Banks sue MBIA over $5 billion restructuring. Reuters.]
7. ↑ ^{7.0 7.1} Banks Sue MBIA Over Splitting Units. The Wall Street Journal.
8. ↑ ^{8.0 8.1} MBIA loses $728 million as slowdown hits bond insurer. Alistair Barr. MarketWatch.
9. ↑ ^{9.0 9.1} MBI 10-K 2008 Item 1 Pg. 2
10. ↑ MBI 10-K 2008 Item 7 Pg. 50
11. ↑ ^{11.0 11.1 11.2 11.3 11.4} MBI 10-K 2008 Item 7 Pg. 71
12. ↑ MBI 10-K 2008 Item 7 Pg. 72
13. ↑ MBIA shares soar after posting profit. Reuters.
14. ↑ ^{14.0 14.1 14.2 14.3 14.4 14.5 14.6 14.7} MBI 10-K 2008 Item 6 Pg. 47
15. ↑ MBI 10-Q 2009 Item 1 Pg. 2
16. ↑ ^{16.0 16.1} MBI 10-K 2008 Item 7 Pg. 73
17. ↑ MBI 10-K 2008 Item 7 Pg. 100
18. ↑ MBI 10-K 2008 Item 7 Pg. 101
19. ↑ MBI 10-K 2008 Item 7 Pg. 102
20. ↑ MBI 10-K 2008 Item 7 Pg. 102
21. ↑ ^{21.0 21.1} MBI 10-K 2008 Item 7 Pg. 103
22. ↑ ^{22.0 22.1} MBI 10-K 2008 Item 7 Pg. 105
23. ↑ Credit Spreads Widen Despite Signs of Recovery. Liz Peek. The New York Sun.
24. ↑ Ambac May Raise More Capital After Reporting Loss. Christine Richard. Bloomberg.
25. ↑ ABK 10-K 2008 Item 1 Pg. 5
26. ↑ ABK 10-K 2006 Item 6 Pg. 35

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