Thursday, February 19, 2009 1 comments

Will Warburg Pincus end up in the private equity hall of fame? They need to pull off a coup with MBIA

When the monoline bond insurers were in the thick of the credit crisis back in early 2008, you may recall some comments we had about Warburg Pincus and its past history rescuing a bank hit by the real estate crisis in the late 80's. I'm not sure what happened to the poster who used to frequent this blog (hope he/she is doing well) but I saw a blog entry at WSJ Deal Journal briefly recapping Warburg's past. Perhaps some invested in MBIA after being comforted by Warburg's past success. So far it has been a disaster of epic proportion for Warburg Pincus and anyone that invested in any of the monoline bond insurers (not to downplay the losses but quite frankly, given how things have unfolded, almost anyone investing in any financial company has likely lost a fortune.) I thought I would quote (extensively) Peter Lattman's blog entry recapping Warburg's past success with the Mellon bank (now part of Bank of New York Mellon):

Peter Lattman for the WSJ Deal Journal:

MBIA’s plan to split itself into two–a muni bond insurer and a toxic-securities insurer–brings to mind Warburg’s two-decade old investment in Mellon Bank, a deal that holds a place in the “good bank/bad bank” investing hall of fame.

In 1988, the Pittsburgh bank, reeling from a portfolio of bad real-estate loans, ring-fenced $1.4 billion of troubled assets and transferred them into a newly capitalized “bad bank” called “Grant Street National Bank.” As part of the recapitalization, Warburg purchased about $150 million in Mellon convertible preferred stock that it later converted into shares, becoming one of Mellon’s largest shareholders.

The troubled loans were marked down about 50% when sold to Grant Street and sold off over time. Then being the late 1980s, Michael Milken, of course, had a hand in the deal, capitalizing the “bad bank” with the sale of about $500 billion of bonds. By 1995, Grant Street’s positions were sold off and the entity was liquidated.

Meanwhile, Mellon’s stock flatlined for several years before recovering over the course of the 1990s. Warburg exited its investment in 1998 for about $1.5 billion, generating 10 times its original investment over the course of a decade. (Mellon merged with Bank of New York in 2006 to become Bank of New York Mellon.)

It is far from clear Warburg will have the same luck with MBIA. About a year ago Warburg made one of the first big bets in a distressed financial outfit, investing $800 million in MBIA at an average cost of $19 a share. (Ahh, remember those halcyon days when monoline insurers were Wall Street’s biggest problem?) Warburg also received warrants that, if MBIA recovers, would reduce the firm’s average cost to about $16 a share.

MBIA has struggled, dragged down by the uncertainty surrounding the subprime-mortgage-backed bonds and collateralized debt obligations it has guaranteed. By separating its troubled business from its core munibond insurance portfolio, MBIA will look to write new municipal-bond business without being encumbered by the toxic structured-finance assets it has guaranteed. It has left $10.1 billion of capital in the structured-finance business, and sent $5.7 billion to the muni insurance company.


I'm not familiar with private equity but from what little I know of that area, the restructuring of Mellon is perhaps one of the top success stories in the last 25 years. It probably isn't as big of a success as some of Wilbur Ross' private equity restructurings, but it still has to rank near the top. When the Obama administration says it wants private capital playing a role in banks, I think they have situations like this in mind (Warren Buffett seemed to be a big fan of getting private capital into the banks and I think the Obama plan was influenced by him.) But if they don't pull of MBIA, they will go down as having made a terrible decision.

Although the MBIA split isn't quite a 'good bank, bad bank' separation, it comes awefully close within the limitations of the insurance business. The difficulty with the present situation is that, unlike the banking crisis in the 80's, we may be facing a protracted period of weak economic growth, not to mention increasing cost of capital. Financial profits are also likely to decline, although bond insurers, like other insurance companies, aren't really correlated with the economy.

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1 Response to Will Warburg Pincus end up in the private equity hall of fame? They need to pull off a coup with MBIA

contrariandutch
February 21, 2009 at 9:14 PM

Actually, MBIA has completely separated out the muni business in a new subsidiary that provides "cut-through" reinsurance for the muni bondholders in exchange for all the unearned premiums. That means the cash has been shifted to the new unit and only the muni holders have a potential claim on that cash. The new unit is indirectly subordinate to holdco but completely separated from the existing insurance co. That means that if the structured business sinks the muni holders, as well as holdco debt and shareholders, will still have that cash left. Barclay's who have a lot of MBIA exposure they have not written down, wrote a rather pissed off note on the subject.
s
(information on the structure of the new unit is in their website)

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