Monday, December 10, 2007 3 comments ++[ CLICK TO COMMENT ]++

MBIA Raises $1 Billion

MBIA has raised $1 billion in capital from Warburg Pincus, a private equity firm. The market likes the move (most bond insurers are up 8%+) but the real question now is whether it is enough. Here is what Warburg Pincus is doing:

  1. Buying 16.1 million shares for $31 ($500 million)
  2. 7yr warrants to purchase 8.7 million shares @ $40 and 7yr "B" warrants to purchase 7.4 million shares @ $40 (total $500 million)
  3. 2 seats on the BOD (out of 13)

Heavily dilutive but it isn't a bad deal in my eyes. About $500 million for warrants that only have value if price goes above $40. Given that the current price is around $33, Warburg Pincus clearly thinks that the stock go up 30% from here within the next 7 years. Pretty bullish statement from Warburg Pincus. Shareholders face the full brunt of the dilution but that is to be expected.

The real question is whether this is enough and whether this will be the end of capital funding activities. If MBIA, and other bond insurers, have to raise even more capital then the situation isn't so attractive.

MBIA also said that mortgage securities keep deteriorating and that it is earmarking $800 million in additional reserves. So MBIA will likely take a bigger loss in the 4th quarter than in the 3rd.

Thoughts on Ambac Based on MBIA's Moves

I think the situation with Ambac would be worse because ABK has a much more CDO exposure (it has the largest CDO exposure of any insurer). But the stock market has priced in a lot of that (ABK is down a lot more than MBI). Based on loss reserves taken by MBIA, I think it's reasonable to expect Ambac's losses to be 2x to 3x what it was in the last quarter.

I think Ambac likely needs to raise $1 billion to $2 billion. MBIA has clearly decided to dilute the shareholders while retaining its future profitability. I think Ambac should do something similar. Diluting the shareholders may be better than using reinsurance and giving up future potential. Issuing preferred shares, which is sort of in-between equity and bonds, is another choice. Of course, there is nothing to stop one from using multiple options.

If warrants are issued and they trade publicly, they are worth considering for those bullish on the stock. Although derivatives like warrants are risky (can go to zero), I think they are a better bet than preferred shares. If Ambac announces that they are going to have a public rights offering, and if I decide to invest in it (still not sure), then I would seriously consider the warrants. The beauty of the warrants is that they have massive leverage while having long life.

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3 Response to MBIA Raises $1 Billion

December 10, 2007 at 7:10 PM

You may want to check out the comments from AccruedInterest. He think that there are more money needed by all the companies. Further, he think that the monoline insurance landscape might change due to investers losing faith in the monolines such that not all the companies will survive.

December 10, 2007 at 10:21 PM

Thanks for the tip Neanderthal. I checked out the post and it is somewhat similar to my view, although I think he expects much higher capital needs.

As AccruedInterest points out, new capital may come from reinsurance, running off the contracts, and so forth. So that dilution may happen over time and not as painful for existing shareholders. Cutting the dividend is another choice (although it only provides a tiny amount: $70 million).

I think there is a risk of dilution for new investors but I suspect it won't be as big as what is being raised now. Overall it's very complex for those sitting on the sidelines. The market may already be pricing in a lot of the dilution (as has been the case with nearly all the financials, including UBS's move today).

I think AccruedInterest's thought that the business model may change is an interesting point. I never considered that (I have always considered whether the current model will survive or completely fail). If the model changes, then the market not place the historical valuation on these companies. One of the attractive things has been the potential for large growth in the future. But if the model changes then growth will be limited.

It will be interesting what the outcome of all this will be. One possibility is what AccruedInterest mentioned (i.e. business model changes). Another (very bullish) possibility is that the market may differentiate between the "worthy" bond insurers and the not-so-worthy. Let's face it, with something like 5 AAA-rated monolines, the field is getting a bit crowded. I wonder if customers will start attaching a premium to the strong survivors. I see a possibility that some bond insurers' brands may be enhanced. What is happening in the bond insurance industry may be similar to what seperated Ford from the other 50+ automobile manufacturers in the early 1900's.

The winner may end up with huge gains. Not only will competition be weaker, the spreads are wide and profit potential is getting better.

December 11, 2007 at 12:12 PM

Just another bit of information. I read in the Wall Street Journal today that Marty Whitman commented that they were pleased with the MBIA deal in that the capital dilution was not as big as they had feared. It seems that they still hold MBI.


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