MBIA (MBI)

The AHERF Loss and Its Effect on MBIA’s Stock Price

15. In 1996, the AHERF bonds were issued, with MBIA’s guarantee. The AHERF bonds were not general obligation bonds backed by tax revenues. By the spring of 1998, it was apparent that AHERF was in financial distress and that MBIA would have to make good on its guarantee. As a result, the investment community was concerned about the possible negative impact on MBIA resulting from its AHERF exposure. This concern was exerting downward pressure on MBIA’s stock price, which fell from a high of $77.94 in April 1998 to a low of $67.62 on June 15, 1998.

16. On July 21,1998, AHERF filed for bankruptcy protection, and MBIA issued a press release stating that the AHERF bankruptcy would have no impact on its earnings because “the company’s unallocated loss reserve [of approximately $75 million] will be sufficient to meet anticipated losses.” The market remained concerned, and MBIA’s stock price continued to fall. On September 2, 1998, AHERF announced that its 1997 financial statements would be restated and should not be relied upon. By September 10, 1998, the price of MBIA’s stock had fallen to $46.30.

17. It was in this context that senior MBIA executives negotiated and executed the excess of loss and quota share contracts, for the purpose of masking the effects of the AHERF loss on MBIA’s earnings and thus allaying the market’s concern. The contracts were negotiated, structured, and documented by MBIA’s then-chief executive officer and chairman of the board (“CEO”) and its then-chief financial officer and later special assistant to the chairman (“CFO”).

18. MBIA first announced a reinsurance solution during an investor call on September 11, 1998, and the news had an immediate positive impact on MBIA’s stock price. By the close of business on September 11, the price had climbed to $52.09 from $46.30 the day before. Ultimately, in a September 29, 1998 press release, MBIA announced that it had obtained $170 million in reinsurance for its anticipated AHERF loss and that as part of the reinsurance agreements it had “entered into strategic business relationships with highly rated reinsurers to provide them with future business.” MBIA did not identify the reinsurers or provide details of the “strategic business relationships.” After the issuance of this press release, and through the filing of MBIA’s third quarter earnings release and Form 10-Q in mid-November, MBIA’s stock price recovered so that by year end it was trading in the mid-60s.

19. The July press release and the September conference call and press release were deliberately or recklessly misleading. When the July release was issued, MBIA’s own internal analysis was that the AHERF loss would likely exceed its unallocated loss reserves. When MBIA announced in the September conference call and the September press release that the loss would be covered by reinsurance, it knew that the excess of loss contracts were not agreements subject to reinsurance accounting but were in substance loans, and that the “strategic business relationships” were mechanisms designed to fully compensate the reinsurers for the amounts they had paid under the excess of loss contracts.

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