MBIA (MBI)

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Bulls: Reasons To Buy Feeling Bullish? Be the first to explain why this would make a good investment See all Bears Reasons Bears: Reasons To Sell MBIA takes a Five Level Downgrade 0% agree MBIA takes a Five Level Downgrade MBIA Inc.'s five-level downgrade by Moody's Investors Service ( June 19th )probably will force it to make $7.4 billion of payments and collateral postings. MBIA has $15.2 billion of assets available to satisfy the requirements, the company said yesterday in a statement. That... read more View or Edit Reason 0 votes 0% agree Send the authors a comment or suggestion Be the first to make a suggestion See All Suggestions

Top Contributors Michael Francis Mark Deluzio Related Articles Ambac Financial Group (ABK) Monoline bond insurers Security Capital Assurance (SCA) Asset-backed securities Collateralized debt obligations

In recent years, MBIA has insured large numbers of collateralized debt obligations(CDOs) such as mortgage-backed securities. These insurance policies were lucrative, and MBIA's revenues rose almost 140% between 2001 and 2006, but MBIA severely underestimated the probability of defaults and undervalued its insurance policies. With the onset of the subprime lending crisis, MBIA was suddenly obligated to cover huge numbers of failed mortgage-backed securities, and 4th quarter 2007 alone the company lost $2.3 billion and reduced the value of its credit portfolios by $3.5 billion.

MBIA's financial problems threaten its perfect AAA credit rating, and the company has been scrambling to raise money to cover the losses. Despite the fact that Moody's and S&P affirmed MBIA's AAA rating, Fitch's went ahead and downgraded the company to AA on April 4.^[1] Just two months after Fitch's January downgrade, S&P downgraded the holding company and the firm's insurance unit to AA. Moody's claimed that it is currently reviewing the company for a downgrade.^[2] Downgrades from the rating agencies for MBIA and its competitors are creating major waves in the financial industry. This fallout would effectively cause all the bonds insured by the downgraded firm to assume the new lower rating unless the underlying credit was AAA. Investors would suddenly hold billions of dollars in revalued securities that were worth much less than they previously thought. Additionally, many issues were bought on MBIA's AAA strength without concern for the underlying security's credit rating. The economic effect of such a situation is potentially drastic, and there is speculation that the U.S. government may intervene or further regulate the industry.

[edit] Business Financials

MBIA generates revenue by writing insurance policies on municipal bonds and other asset-backed securities, protecting the holders against default. It also collects interest on its own investments by reinvesting float like any other insurance company. Also, a small percentage of revenue comes from fees for asset management. MBIA’s total insured par is $618 billion, the majority of which are investment grade issuances by public entities such as U.S. state governments. Below is the revenue breakdown for fiscal year 2006.^[3]

[edit] Key Trends and Forces

[edit] 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. Wide 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 2007, which leads to two offsetting trends for MBIA:

• First, wider spreads indicate that losses on securities insured while they had narrower spreads become more likely.
• Second, wider spreads make future business more attractive due to the higher premiums.

Generally, when markets are highly liquid, spreads narrow, competition for credit insurance business intensifies, and prices are driven down. When markets suffer from less liquidity, MBIA has generally fared well by demonstrating expertise in insuring complex, and, due to its size, large transactions in a less competitive environment.

Recently, the company has come under pressure from the current poor state of the securitization market and the market declines in some of the credit derivatives they underwrite. Furthermore, declining credit quality of mortgage backed securities and structured finance products underwritten by MBIA has investors skittish about the company's costs for these products; it is more expensive to underwrite these policies with a lower credit rating.

[edit] Growth in Capital Markets

The fixed-income markets that MBIA operates in have seen double-digit annual growth over the previous 3 years^[4]:

• Public finance: 9%
• Structured finance: 22%
• International: 30%

This growth provides a more robust array of securities to be insured, though in the longer term it has also attracted new competition for business, driving down pricing and spreads.

The international segment has been growing most rapidly as capital markets abroad begin to come into their own. The majority of this international exposure is in Western Europe and the UK.

[edit] Credit Ratings

MBIA is largely reliant upon a strong credit rating from the major rating agencies such as Moody's (MCO) and Standard & Poor's. Credit ratings provide objective judgments about the insurer’s ability and willingness to pay insured parties when necessary. Declines in the credit quality as reflected in the company’s rating could limit the business it wins from customers and raise the firm's cost of capital.^[5]

Some investors are worried that the current AAA rating is not sustainable given that a huge portion of the firm's investment portfolio (and, hence, claim paying ability) is tied up in mortgage-backed securities and asset-backed securities. Some of MBIA's portfolio of these assets has already been written down due to subprime lending defaults, and MBIA lost billions of dollars in 4th quarter 2007 as a result.

[edit] 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.

[edit] Competition

The guarantor/financial insurance business is highly competitive. The only barrier to entry, which deters smaller but not necessarily larger financial entities from entering the market, is a minimum capital requirement necessary to maintain a strong credit rating. Largely, companies compete on a mix of price and consumer trust and judgment of the insurer’s ability to pay.

MBIA has the highest credit rating, and therefore tends to compete most directly with other triple-A guarantors, including:^[6]

• Ambac Financial Group (ABK)
• Security Capital Assurance (SCA)
• Financial Guaranty Insurance Co.
• Financial Security Assurance, Ltd.
• Assured Guaranty
• CIFG

However, the company also competes with alternative forms of insurance, including derivative contracts like credit default swaps, etc, which are written by nearly every major bank and financial institution. This makes the effective playing field in the credit insurance business substantially larger and more competitive.

[edit] Market Share of U.S. Public Issuances

MBIA (and its principal competitor Ambac) focuses a large portion of its business in the U.S. public finance issuance market. Market shares as a percentage of newly issued and insured obligations were:

[edit] Footnotes

1. ↑ [hhttp://www.bloomberg.com/apps/news?pid=20601087&sid=akPCht55V.yc&refer=home Bloomberg]
2. ↑ SmartBrief
3. ↑ from MBI 2006 Annual Report (page 31)
4. ↑ Taken from Moody's 2006 Annual Report (page 5-6)
5. ↑ Taken from MBI's 2006 Annual Report (page 22-23).
6. ↑ Taken from ABK's 2006 Annual Report (page 16-17).

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