You again choose to completely miss my point MBIA is using a definition of “claims paying resources” which differs from that of the industry association. Notably, MBIA appears to be the only bond insurer NOT to be a member of the industry association. It thus appears to be using a term, defined by the association, to its own advantage to mislead the public. This is no doubt legally permissible, since the term is defined in an operating supplement subject neither to GAAP or SAAP, but it speaks again to the lack of trustworthiness of management. Warren Buffett and other investors stress that ultimately when you invest in a company, you invest in management, so this is not a trivial issue.

Second, you are completely wrong about bond insurance, and I am surprised that you can claim to be knowledgeable yet be in error about something so basic. The insurance premiums are paid by the issuer. See here, for instance:

Issuers that meet certain credit criteria can purchase municipal bond insurance policies from private companies.

Yes, the cost of the insurance is reflected in the cost of the bond, but the insurance policy is with the issuer, which in this case is the municipality, and they make the premium payments (for structured credits, the monline wraps usually were not for the entire deal, but the principle remains the same).

A municipality has every reason to try to get out of an insurance policy. The ONLY reason they entered into these agreements was to improve their rating (for instances, to turn an underlying A into an AAA). If their rating is A or higher, any insurance from MBIA is useless. Municipalities try to cure their defaults as quickly as possible (historically, they typically miss only a payment or two) because failure to remedy a default would make it very difficult for them ever to sell bonds again. They have no motivation to stick the insurer and not remedy a default; the long run costs to them are too high.

It wouldn’t be worth it for a small municipality to fight (the cost of litigation would probably exceed any savings on the insurance) but a large issuer might, or smaller issuers could band together.

And per 2007, I expect both investors and buyers of insurance to be looking pretty closely through Ambac and particularly the far more aggressive MBIA’s assurances that everything was fine re their ratings. There was one incident cited here where the MBIA CEO insisted they needed no more capital and the very next day, one of the rating agencies issued a sharp rebuke, saying in effect that if they didn’t raise more capital, they were at risk of a downgrade.

There will be synergies between any lawsuits. Any overly rose statements publicly or in the course of selling bond guarantees about their ratings strength could be used to push claims of misrepresentation and fraud. Any evidence produced in litigation in a suit that actually goes to trial can be used by subsequent claimants, they become a matter of public record unless sealed (and there is no reason to expect records of any proceedings to be sealed).

Thus successful shareholder litigation that produced evidence of misrepresentation by the monolines would lower the cost to policyholders of pursuing claims and vice versa.

MBIA would be smart to settle any claims along these lines, but the company has consistently overplayed its hand.

Preventing bond insurer downgrades was important enough that both the heads of the firms that would be affected (such as John Thain at Merrill) were involved in the January negotiations, and Henry Paulson tried to give an assist. It will lead to considerable further losses in the municipal bond market and the structured credit market, which will in turn lead to further losses at banks and investment banks which are already short of capital. This was widely considered to be an outcome to be avoided, but you brush it off.

I don’t work in the industry and can’t speak for the industry defintion, but Ambac, which I’m more familiar with, also has a seperate category for “present value of future premium”, which is seperate from unearned premium already collected. I suspect you are referring to items similar to that. I don’t know what MBIA is including in categories such as that but it sounds similiar to what Ambac is doing. Given that MBIA and Ambac were the founders of this industry and made up more than 50%+ of the industry, I would have no reason to suspect that they are not following the industry standard. They are the industry! Rating agencies and regulators have approved that system in the past so I don’t think they have any problems. The bond insurers did go through past crisis (New York default in the 70’s; Eurotunnel default in 2000’s; etc) and no one has raised these issues until short-sellers such as William Ackman made a big deal out of nothing.

YVES: “Moreover, for any municipality or structured deal where the underlying credit quality is single A or better, the MBIA insurance is now a complete waste of money.”

Why is it a waste of money? If someone defaults, the bond insurers will still make the payment. If you had two identical bonds, one with insurance and one without, holding the one with insurance is still better. Even if the insurance company is in run-off (the worst case), there is a high chance of you getting paid upon default; whereas the bond without insurance has not back up. The market is pricing the bond with insurance at a lower price but that is because the market is totally irrational right now.

Furthermore, the municipalities are not the ones that pay the insurance. It’s the bond buyers. The insurance actually LOWERED the cost of bond issuance for the municipality! They have nothing to gain from terminating any contract (assuming it was even possible).

The party that may be dissapointed is the bond buyer, but given that the insurance was to pay interest and principal upon default, not to guarantee ratings, I can’t see them having much merit. Politicians are dumb and act well after the fact (Elliot Spitzer almost destroyed these companies a few months ago for example) but that’s why we have courts. Speaking as an Ambac shareholder, I expect the courts to uphold any signed the contracts: both from the insurer and from the buyer.

It’s obvious to me who will not want to pay the premiums. It’s not the municipal bond buyer. It’s the banks who bought the structured products. Many of them seem to have bought insurance, not to make whole upon default, but to arbitrage the rating (i.e. can hold more AAA-rated bonds than say A-rated bonds).

YVES: “I expect anyone who entered into a contract with MBIA in 2007 to be looking for a way to get out of it. And given that management’s repeated assertions, that concerns about their credit quality and rating were unwarranted, proved to be false, I think a lawyer could get a case past summary judgement.”

The rating still has no impact on the signed insurance contract. I hate to beat this point to death but bond insurers do not guarantee ratings. All the rating does is to indicate probability of payment. The probability is getting lower but it is a whole lot better than a counterparty in a CDS contract written by an unregulated hedge fund paying upon default.

YVES: “That’s a long-winded way of saying I wouldn’t count my chickens before they are hatched, particularly in this case.”

I am not counting my chickens. We are still a long way from getting through this storm. It doesn’t help when misleading views, such as what bond insurance actually means, gets propagated by short-sellers and their allies. It’s easy to blame some small company for the world’s problems but the truth ain’t that. You know something is wrong when short-sellers claim that the fate of the entire universe seems to rest on the monoline’s shoulders…

You have clearly not looked at the schedule I referenced in the operating supplement. The installment premiums are SEPARATE AND APART from unearned premiums. The industry definition of CPR is surplus + unearned premiums. Those two together come to less than half of the $16 billion that MBIA claims in CPR through its awfully liberal, non-standard definition.

Moreover, for any municipality or structured deal where the underlying credit quality is single A or better, the MBIA insurance is now a complete waste of money. I expect anyone who entered into a contract with MBIA in 2007 to be looking for a way to get out of it. And given that management’s repeated assertions, that concerns about their credit quality and rating were unwarranted, proved to be false, I think a lawyer could get a case past summary judgement.

And once they do that, they get to do discovery, which means go through internal documents and e-mails. Think they won’t find something damning? There is almost without exception in these situations a worry-wart who was ignored.

That’s a long-winded way of saying I wouldn’t count my chickens before they are hatched, particularly in this case.

A lot of the premium, particularly on the muni bond side, is already collected. The amount that is future premium is around 15% of total (for Ambac; MBIA is probably similar). As long as the insurance buyer has an obligation to pay the premium, why should it not be counted? And if it is not to be counted, then shouldn’t the potential liability arising from any claims be ignored as well? Or do you come from the William Ackman school of accounting, where you don’t discount anything to present value, ignore unearned premiums (but either collected or contractually obligated to be paid), and ignore taxes?

S: “I wonder does that PV calculation include the PV of contingent liabilities when the bond holders who have strict investment criteria are forced to sell at a loss due to forced divestitures? “

You don’t seem to understand bond insurance. The bond insurers never guarantee AAA ratings! What they do guarantee is timely interest and principal payments upon default. The insurers never guarantee that the price of a bond won’t drop, no more than they claim it will go up.

If someone sells their bond and takes a loss, that’s their problem. It’s true that some investors, particularly banks, were using bond insurance as a ratings arbitrage but the guarantors never guaranteed ratings.

S: “Also, as for the rediculous assertion about write ups, that is truly the last refuge of the scoundrel”

We shall see. I’m putting money where my mouth is and what are you doing, sir? If the accountants are as incompetent as I think they are, we should see some write-ups really soon… likely by the end of this year (if my thinking is right, mortgage default rates should stabilize within 6 months, and then some marks to market should reverse)… Not just at the monolines but in many of the banks as well… And no, this isn’t the refuge of a scoundrel, although I can see how you may be mistaken since you may have been hanging around them too much; this is my belief…

Sivaram Velauthapillai said…st lreast you have an eventual short sequeeze to look forward to on the steady decline down. When you don;t have a business model, you are worth the PV of your existing book which is looking increasingly, though not definitiviely, like it is a funtion approaching zero. Also, as for the rediculous assertion about write ups, that is truly the last refuge of the scoundrel

The way they are calculating “claims paying resources” is analogous to and as fundamentally dishonest as lenders who have been counting negative amortization as profits/assets.

Unbelievable.

i too would be extremely suspicious of additional claim paying resources used to support a book. it seems to me in determining the quality and respective characteristics of the CPR’s used above and beyond industry standards one would be forced to make assumptions on little information. I would be more interested in analysing the quality of the industry standard CPR’s relative to the liabilities that they must support while removing those CPR’s that are above and beyond the norm.

I would be more interested in dropping seemingly weird CPR’s from any analysis or at the very least breaking apart CPR’s by commonly used industry wide resources.

like I mentioned above the unknown unknowns are usually the real destroyers.

BTW, the parallel to capitalizing interest margins at a bank is not exact. If a premium stream is guaranteed to be paid under an old style fixed premium insurance contract, or it goes out of force, actuaries typically take that into account in setting reserves. We certainly do that in life insurance.

To the monoline bears and the clueless, this may seem like “stretching the truth” but it kind of makes sense to me (as a layperson shareholder). Many of the claims that may arise (interest and principal due upon default) are due over the next 10 to 20 years (in some cases as much as 40 years I believe.) So, it doesn’t make any sense to require $15 billion in cash up front. As long as the cash will be there, the claims will be met. The bears, most of whom really don’t know much about credit instruments, never seem to understand why changes in credit instruments held to maturity doesn’t mean much. If you buy a bond and it drops in value it doesn’t mean anything if you get re-paid on maturity. Unfortunately for monoline shareholders like me, the accountants are totally incompetent with their fair value accounting (they have caused hundreads of billions in losses for the banks in my opinion (if marks reverse) and the accounting profession really needs to re-evalute themselves if my scneario unfolds (the rating agencies also seem quite incompetent.))

Furthermore, a lot of the premium is pre-paid so the insurers have collected the money but haven’t claimed it. This is generally the case with muni bonds (they are pre-paid upon issuance). Insurance on structured products may not be pre-paid to the same degree (however, most of the core business of these monolines are the muni bond business, and if someone wants to “cancel” insurance on a structured product (assuming it’s possible), the mononlines will happily avoid receiving the payments while getting rid of the exposure.) The fact that a lot of the insurance is pre-paid is one reasons the monolines don’t face a “run on the bank” and can operate for 10+ years without any new business. This is also why the regulator really can’t do anything legally (there is ample claims-paying ability; politicians, however, are irrational so, although Eric Dinnallo seems to be a good guy, it’s hard to say if something crazy will happen.)

Needless to say, the short-sellers, who otherwise wouldn’t make any money, propagate misleading opinions in order to overcome the claims-paying ability. Where I can see a weakness with the monoline is if they need to post collateral (SCA had to) or pay losses right away. I’m not an expert on this but this is likely only possible with structured product insurance. The short-sellers have poucned on this weakness lately (they really have nothing else to do add anymore). I suspect the insurance buyers (mostly banks) will not have an economic interest in asking for payment up-front (assuming they can) because it will bring down the whole system and they will end up with nothing anyway. But that is the only risk I see.

On a different note, the short-sellers seem to muddle the issue further by bringing in risk related to the investment business of the monolines and mixing that up (on purpose I assume) with the insurance business. Most monolines have a side business where they manage portfolios (money collected on behalf of issuers are invested rather than sitting around doing nothing) and that investment business is sensitive to ratings, asset declines, and so forth. This is where MBIA and others may need to post seemingly large collateral upon rating downgrade or possibly capital losses on positions.

For instance, William Ackman’s new attack on FSA, a AAA-rated guarantor with seemingly low exposure to subprime mortgages, seems to be related to their investment portfolio and not necessarily their insurance business. I’m not privy to Ackman’s analysis or presentations (only the shadow world consisting of some investment funds and hedge funds have access) but he seems to be claiming that FSA’s assets have declined substantially and hence their liabilities are higher than assets by several billion (he has said that all the monolines except BHAC will fail (I assume this includes Wilbur Ross-backed Assured Guaranty as well) but his main point with FSA seems to be the investment losses). Of course, the fact that assets (say US Treasuries) can be sold off to meet the collateral requirement is never mentioned by anyone (I assume purposely to paint a more riskier picture of the monolines.)

I suspect William Ackman’s bet against FSA is going to fail but one can never be sure (short sellers just need irrational behaviour in markets, not necessarily fundamental detrioration). I don’t know about the quality of assets FSA has in their investment portfolio but losses don’t really mean much if they are simply paper losses. In any case, assuming my impression of William Ackman’s primary attack is correct, none of this really has any impact on FSA’s insurance subsidiary. All this just impacts their “holding company” and their parent company, supposedly a conservative-run French bank, Dexia.