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Why I added to MBIA

I decided to re-establish my original position in MBIA Inc.  I did so after the drop Tuesday and Wednesday that was precipitated by Bank of America’s offer to buy MBIA holding company indentures.

I don’t want to rehash the background of Bank of America and MBIA in this space.  For background on the MBIA consent solicitation and the tender offer by Bank of America in response I would recommend this article by Christian Herzeca, this Bloomberg article, and this blog post by analyst firm BTIG for background.

What I want to focus on is why I decided to add my position.  I could have just as easily cut my losses and run.  The market sucks this week and I am losing money.  My instinct right now is to cut my losses (and in most places keep my profits) and sell.  Moreover, I do not often add to a losing position, which is what I am doing with MBIA.  I try to make a habit of doing less of what doesn’t work, and while MBIA has been profitable for me through most of the time I have held it, it recently has not been.

Yet I decided to add.  Why?

I decided to add to the position because I believe that the market has unfairly priced in an increased chance of an NYDFS takeover of the securitization subsidiary (MBIA Corp.) that would lead to a bankruptcy of the holding company (MBIA Inc.), and has decided to ignore a number of the potential positive catalysts that could occur over the next couple of months.  It just seems to me like a case where the market got the wrong news at the wrong time and panicked a bit too much.

Positive catalysts for the stock in the near term

The positive catalysts include:

  1. A positive ruling on the Article 78 proceedings (this is a verdict on the legality of MBIA severing its municipal insurance business from its securitization business.  It is being contested by Bank of America.  It has been on the desk of Judge Kapnick for over 5 months now)
  2. A positive summary judgment on the fraud and breach of contract lawsuit that MBIA has against Bank of America.  There was a recent article on the summary judgment here.
  3. Perhaps a bit more nebulously, the response of MBIA to Bank of America.

To expand on that third point, I find it hard to believe that MBIA did not consider the potential that Bank of America may respond this way.  By issuing the consent solicitation, MBIA was effectively backing Bank of America into a corner.  The holding company wanted to remove the remaining necessary ties to the securitization business by redefining the holding company bonds so that they would no longer have the ability to be accelerated in the event of a default at the securitization subsidiary.  All of Bank of America’s claims reside in the securitization sub and much of them are subordinated in the event of a bankruptcy.  Thus MBIA was really about to cut Bank of America off at the knees.  So Bank of America responded in kind.

MBIA Counter-measures

There are a few different counter measures that MBIA could respond with.  I can’t take credit for these ideas.  I got them from some of the very astute tweeters that follow MBIA (hat tip to @cherzeca,   and @alex_ryer)

  1. A consortium of largest holders of the common stock combine to put together a better offer for the bond indentures.  The idea was put forth by BTIG in this article, where they said “we would not be surprised to see an announcement that some of MBIA’s deep-pocketed friends had formed a limited-liability corporation (LLC) that they would use to top BAC’s offer and buy up the 50% of the 5.7% Notes that would be needed to push a consent solicitation over the top.”
  2. MBIA buys the indentures back themselves.  The bond issue that Bank of America is going after are callable by MBIA.  It wouldn’t be cheap, I read that the price to call the bonds is par plus future interest payments.  MBIA would have to pay for the re-purchase through a new private placement which also would be more expensive than the existing indentures.  But it would effectively allow MBIA to pressure Bank of America with the leverage that if Bank of America does not pay a reasonable settlement, the MBIA holding company could put the MBIA Inc. insurance subsidiary into bankruptcy with no consequence to the holding company.

The third option that MBIA has is to let Bank of America buy up the indentures.  Now I haven’t heard this from anyone else so maybe I’m off-base here, but it seems to me that it is significant that Bank of America is buying the bonds because they don’t want the holding company to have the option of throwing securitization sub into bankruptcy without consequence to the holding company.  But by buying bonds of the holding company that are contingent on the viability of securitization sub it becomes even more in Bank of America’s interest to not see the insurance subsidiary go into bankruptcy.

By allowing Bank of America to buy the bonds, MBIA is raising the probability that the worst case outcome in their dispute is that the MBIAwalks away without a bankrutpcy, and with the municipal insurer National intact.   The National franchise is worth maybe $20 per share, so that outcome is extremely accreditive to the current share price.  If we could end this all today with this outcome I would take the consequences.

Liquidity

The final piece of the puzzle is the company’s liquidity, which is the other element that has the market spooked.  The securitization subsidiary has a limited amount of liquidity to pay claims.  While the overall statutory surplus at the securitization subsidary is $1.1 billion, a little less than $500 million of this is invested in common stock.  What the common stock refers to is the interest the securitization sub has in its subsidiaries, primarily in UK Holdings, which does business in Europe, and makes up about $450 million of that common stock number.  This $450 million is based on the statutory capital available at UK Holding, which is not immediately available to MBIA.

If you remove the common stock from the equation, MBIA Inc. has $386 million in cash and liquid assets, and another $250 million or so that is in bonds.  While the company has been non-committal about how long this cash will last them, the consensus is that it is more than enough to get them through the first half of next year.

While I see how the securitization sub will eventually be pushed into liquidity problems if nothing changes, I think that it is far enough off that I can discount it for now.   My re-established position in the stock is based on much shorter term factors that should play out before year-end.  I am willing to wait this out a month or two, and see how it plays out.

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4 Comments Post a comment
  1. Had a thought to add for discussion in response to your post. Let me know if you think I am off base:

    “By allowing Bank of America to buy the bonds, MBIA is raising the probability that the worst case outcome in their dispute is that the MBIA walks away without a bankrutpcy, and with the municipal insurer National intact. The National franchise is worth maybe $20 per share, so that outcome is extremely accreditive to the current share price. If we could end this all today with this outcome I would take the consequences.”

    If BAC really has MBIA cornered, what puts the liquidity of the public finance sub and the holding company out of the settlement equation? MBIA has booked a $3.2B reserve against the case outcome/settlement. What if the best BAC will offer is settling for a wash? ($0) In that scenario, MBIA would have to plug a $3.2B hole in the balance sheet of the securitization subsidiary, or go into bankruptcy. Which would MBIA choose? To the degree they know the outcomes, BAC can make a settlement offer that is just a little bit better than a disorganized bankruptcy of the whole company. Maybe it is $1B, or $2B, or $0. I don’t personally know. BAC can probably figure it out, approximately.

    My assumption here is that BAC would rather save the $3.2B (or whatever amount) of the case outcome/settlement and take a bath on the tranche of bonds they bought up to block the solicitation.

    You could sum up my argument as suggesting that since BAC has the power to put the whole company into bankruptcy, they likewise have the power to force a settlement that drains almost all of MBIA’s equity.

    My thinking may be flawed. There may also be constraints I am not aware of that factor into the equation.

    Regardless, thanks! I’ve followed your blog for a while now, you have lots of good insights!

    November 16, 2012
    • Sorry it took me so long to reply. I’ve been too busy writing the piece on IMH. I think that the piece that changes things is that $5 billion+ of BAC claims on MBIA are CDS, and CDS would become subordinated to other claims in the event of a bankruptcy. My understanding is its not considered true insurance in the eyes of court. So if BAC actually lets MBIA Corp go bankrupt they become a junior debtor and who knows what they end up getting.

      So its complicated. BAC wants to push MBIA to the edge but its not really in their best interests to push them over.

      November 20, 2012
  2. Matt #

    I don’t understand why you “do not often add to a losing position”. Adding on the way down is pretty standard for value investors.

    November 17, 2012
    • Its just my strategy. I find that if I add to losing positions some times I get trapped into what I think is a good idea but its because I’ve missed something. I mean nobody is perfect, there is always the possibility that there is something you don’t understand or have overlooked. So if the market isn’t confirming my view I don’t add.

      November 20, 2012

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