MBIA vs Ackman
The biggest flaw in Mr Ackman model is that he doesn’t appear to know the difference between an “insured credit default swap” and a plain vanilla credit default swap. That’s enough to dismiss his alleged analysis as self-serving propaganda. In most civilized countries, individuals actively campaigning to destroy important financial institutions would be behind bars where they belong. Mr Ackman has been short MBIA for many years and his analysis has been wrong for many years, the travails of MBIA are the results of regulators-imposed and misguided changes in accounting rules namely SFAS133.
This is a most important point:
Mr. Ackman has been consistent in his suggestion that his estimates of loss are more accurate than the company’s. He alleged, in his 2002 attack on the company, that our portfolio subject to FAS 133 would have $2 — $3 billion of losses. That portfolio, which has largely amortized or been prepaid at this time, experienced no loss. We don’t believe there’s any basis for giving his current estimates any more credibility than those from 6 years ago.
MBIA letter on “Bond Insurer Transparency; Open Source Research”
Ladies and Gentlemen:
We have completed a review of the letter you received on January 30, 2008 from William A. Ackman of Pershing Square Capital Management, LP, captioned “Bond Insurer Transparency; Open Source Research”. We would like to share with you our comments on the letter, including our response to it’s major errors and omissions.
The letter and the model itself are used as support for estimates of the potential for bond insurers MBIA and AMBAC to incur claims on credit enhancement contracts we’ve written on collateralized debt obligations (CDOs) and residential mortgage backed securities (RMBS). Mr. Ackman has a large short position in the shares and credit default swaps (CDS) of AMBAC and MBIA by his own admission, and the letter is clearly intended to influence the prices on those interests to his gain. Consistent with this, Mr. Ackman develops potential loss estimates that are a multiple of those estimated by MBIA, the ratings agencies and other serious analysts. The “Open Source Model” is an attempt to add credibility to those estimates, as is his assertion that the work of identifying the collateral underlying the CDOs was conducted by “a global bank.” We can only speculate as to the reasons the “global bank” desires to remain anonymous; but we are mystified as to how research conducted anonymously, and disclaimed by the party bringing it to the public could aid in enhancing transparency.
The model and the data appear to have some major deficiencies, as follows:
— The model is described as a “security by security” analysis, while it actually uses an averaging of 1267 randomly selected securities to estimate losses. This is a much less specific approach than the loan by loan analysis undertaken by MBIA on most of our portfolio in formulating our loss reserves and capital forecasts.
— Assumptions driving loss estimates are proprietary to “Global Bank’s” trading model. This is a particularly opaque approach to enhancing transparency.
— The model does not take account of the structures of CDOs and our contracts that provide us protections. The model does not appropriately capture the triggers and cash diversion mechanisms that support the senior interests, nor the fact that we cannot be compelled to settle contracts in 2 years, as assumed. The ultimate principal payments on many of our contracts will take place 30-45 years in the future, and in 8 of the 16 deals we’ve done in 2007, we only guarantee payments that would occur at ultimate maturity.
— The model doesn’t take account of the tax impact of losses.
— The analysis of RMBS transactions employs a steadily increasing default rate which increases by the trend established in the three most recent months. In effect, the model assumes that the elevated default rates expected in the next 18-24 months continue for the rest of the lives of the securities. Although it’s not fully described, it seems likely that this will result in default rates being in excess of those listed in the appendix.In addition to using a simplistic model that ignores many protections built into the CDOs and applying highly conservative assumptions to generate sensational “headline” numbers, Mr. Ackman also makes other
specific points, which are also incorrect.A brief analysis follows:
— It is asserted that by using internal estimates of credit losses, the bond insurers are somehow “determining the amount of statutory capital.” This is peculiar. All financial institutions who take and manage credit risk in buy and hold positions are required to make estimates of uncollectibility or credit impairment. MBIA has a rigorous process for determining the amount of credit losses in our portfolio of financial guaranty policies and our CDS contracts (it must be remembered that our CDS have the character of financial guaranty insurance policies, not tradable CDS as transacted by most market participants). The process of recognizing loss on our contracts for statutory reporting is governed by SSAP 5, which is consistent with FAS5 (Accounting for Contingencies). Our reserves are based on reasonable estimates of probable losses, in accordance with the guidance. There is no provision in GAAP or statutory reporting for reserving based on worst case hypothetical losses. In no way does the fact of internal estimates permit a bond insurer to “determine statutory capital.”
— It is also alleged that MBIA has said that “all mark to market losses would reverse to zero.” This is incorrect. We have consistently stated that in the absence of credit impairment, the mark to market would reverse over time. We have made that disclosure since the advent of FAS133, and only in Q4 2007 have we had an impairment of a contract subject to FAS 133.
— Mr. Ackman has been consistent in his suggestion that his estimates of loss are more accurate than the company’s. He alleged, in his 2002 attack on the company, that our portfolio subject to FAS 133 would have $2 — $3 billion of losses. That portfolio, which has largely amortized or been prepaid at this time, experienced no loss. We don’t believe there’s any basis for giving his current estimates any more credibility than those from 6 years ago.
— Finally, Mr. Ackman incorrectly suggests that MBIA had some scheme to avoid taking “live questions” during its fourth quarter earnings call. Our four hour call consisted of a two hour management presentation and two hours of questions — about 80% of the questions, including Mr.Ackman’s, were received in advance of the call, but every one of them, and virtually all the questions received during the call were answered.
Related:
MBIA: Is Fair Value Accounting a Good Deal for Investors?
February 14th, 2008 at 1:35 pm
[...] Alea wrote an interesting post today on MBIA vs AckmanHere’s a quick excerptMBIA vs Ackman The biggest flaw in Mr Ackman model is that he doesn’t appear to know the difference between an “insured credit default swap” and a plain vanilla credit default swap. That’s enough to dismiss his alleged analysis as self-serving propaganda. In most civilized countries, individuals actively campaigning to destroy important financial institutions would be behind bars where they belong. Mr Ackman has been short MBIA for many years and his analysis has been wrong for many years, t [...]
February 14th, 2008 at 2:30 pm
[...] the Alea blog, some strong words: The biggest flaw in Mr Ackman model is that he doesn’t appear to know the [...]
February 14th, 2008 at 9:14 pm
jck, could you clarify the difference between an “insured credit default swap” and a plain vanilla CDS?
I know the monolines used “transformers” to convert CDS into bonds which they could insure under their charters, but as I understand it the difference between those insurance contracts and true CDS was purely a legal fiction.
February 15th, 2008 at 2:07 am
Tim:
With a plain vanilla CDS, the premium ceases in case of a credit event and you get par value in cash in exchange for defaulted bonds upon default.
With an “insured CDS”, the premium doesn’t cease in case of default and you will get par value at the original maturity, the insurance merely replicates the cash flow of the underlying. In other words if you insure a 20 year bond and it defaults next week, you get your money back next week with a CDS and in 20 year with an insured CDS.
So it’s not a legal fiction, the cash flows are vastly different.
February 15th, 2008 at 3:41 am
jck,
Gotta tell you, enough of what MBIA said is counterfactual to make me doubt a lot of what they represented re their CDS contracts, which is the most important point of difference.
First, Ackman said clearly that he was disallowing the tax shield because of the high likelihood that MBIA would continue to be unprofitable. Their muni business fell off a cliff, and no one expects them to be writing any more guarantees for structured credits. Failing to acknowledge that, and just implying that Ackman is a dope, is disingenuous.
Second, the securities weren’t at all randomly selected. I don’t have the letter before me, but it was ALL the ABS CDOs and RMBS, I think for 2006-2007. So that charge is incorrect.
Third, what about the CDS written for negative basis trades? Wouldn’t those be conventional CDS? MBIA makes it sound as if all their CDS were financial guaranty insurance policies. I have read elsewhere (maybe Egan Jones’s analysis?) that their CDS do accelerate like the ones written by IBs (no idea what proportion).
Fourth, several analysts who don’t have shorts (Egan Jones, JP Morgan, and I forget who the third was) came out with loss estimates much worse than Ackman’s.
Fifth, the bit about the conference call appears to be a lie. Bloomberg reported that they took only written questions submitted in advance and also limited who was permitted to participate in the call (ie, if they did decide to relent and took a few live questions, it was from friendly parties). If they will lie about something that trivial, it calls other things into question.
February 15th, 2008 at 3:52 am
“The model is described as a “security by security” analysis, while it actually uses an averaging of 1267 randomly selected securities to estimate losses. This is a much less specific approach than the loan by loan analysis undertaken by MBIA on most of our portfolio in formulating our loss reserves and capital forecasts.”
You must be NUTS to believe mbia management forecast, these guys were saying their HELOC and close end seconds transactions would have ZERO losses in OCT 07. now they say they will lose $800m, pretty darm likely understated since they were under capital raising pressure when they said it. they also say they will take zero losses on their $9b of CDO squareds. ackman might be overstating based on self-interest BUT MBIA MANAGEMENT IS ALSO DOING THE SAME based on self-interest. you really think Chuck chaplin wants to give up his $800,000 paycheck plus stocks and options. you really think marty whitman going on cnbc and pumping the stock up is acting from the kindness of his heart?
February 15th, 2008 at 4:09 am
alea, you seem to have found yesterday that people act on their own self interest when trying to profit and ackman should be jailed for it. you love mbia management dont you?well then why SEC has issue an apology for ackman and charged mbia for millions of dollars for fraud?why mbia management is pretty much the only people in the financial community who thinks they will lose virtually no money on cdo squared transactions. why they are pretty much the only institutions who dont they they will lose any money on CMBS transactions, perhaps you should update your opnion that they are doing that out of altruism and honesty
February 15th, 2008 at 4:09 am
archer:
to my knowledge, their CDS are all financial guaranty insurance policies, a.k.a insured CDS. Acceleration provides further credit enhancement for super senior CDS so that’s a plus for MBIA. Both parties have interests to defend, no doubt about that, but the short side is playing on a misunderstanding between mark to market losses and default related losses. The Ackman analysis has been proven wrong on that point. Mark to market losses as no predictive value as to what default losses will be.
February 15th, 2008 at 4:15 am
fernando:
I have no interest long or short in MBIA. The fact is Ackman has been badmouthing MBIA for years and his analysis of losses has been proven to be wrong 5 years in a row.
February 15th, 2008 at 5:51 am
From MBIA’s letter:-
So, what does that say about:-
(a) the other 8 out of 16 written in 2007; and
(b) deals done prior to 2007?
There’s something not quite right in that statement, IMO.
February 15th, 2008 at 6:57 am
Brady:
You can always find something sinister if that’s what you want.
Some deals guarantee payments at maturity only and some other deals can be “accelerated” that is pay before ultimate maturity at the option of the guarantor.
February 15th, 2008 at 9:53 am
jck,
Maybe…but as a lawyer, I see some very specific language, as far as numbers and time are concerned.
They could have added on something like, “…and our other deals were done on similar terms.” However, they didn’t even address their other deals at all.
The point is, who knows? I don’t, you don’t. The company does and, presumably, the insurance regulator does, as well.
However, as the New York State Insurance Superintendent said in his testimony:-
Meaning, I presume, he knows what the companies know. I also assume that he’s listened to the arguments which MBIA promotes in its letter, and has carefully considered what it’s said.
Nevertheless, he presently believes that it’s bad enough to (maybe) warrant something like this:-
February 15th, 2008 at 10:14 am
Brady:
I am not a lawyer…There is no question that the monos made a big mistake going into structured finance just like the credit rating agencies did by putting”credit” rating into what are quant strategies.
The problem has I see it, is that the mark to market losses from the structured finance side flow back to the main insurance company and impair their statutory capital. I don’t see the economic point of marking “insured” CDS to market and that where all troubles start, and I believe the rating agencies supported that view up to 2 or 3 months ago. So the monos did a lot of dumb things but they also have been taken for a ride not just by the shorts but also the rating agencies flip-flopping on the MtM issue and the regulators. Scrap MtM on “insured” CDS and all is fine.
February 15th, 2008 at 10:22 am
jck,
I guess that’s the crux of the issue: why are we talking about physically splitting up the companies, if we are dealing with accounting principles, rather than real issues?
I’m sorry, but I can’t believe that everything would be fine, if we scrapped MtM on the insured CDS’s. There’s something else happening here - something which is causing an informed and experienced insurance super to propose the most extreme solution I’ve ever heard of in the insurance industry.
February 15th, 2008 at 10:41 am
Brady:
Well, can the insurance super change MtM accounting rules, I don’t know.
The split/ring fencing would work fine too, then what has to be done is to recap the structured finance side, so that the CDS counterparties don’t look through the insurance as they do now.
February 15th, 2008 at 12:18 pm
Any opinions on what the $42b ceded to Channel RE looks like? These little bundles of joy could be on there way back to MBIA’s balance sheet.
February 15th, 2008 at 12:34 pm
While I read the above comments with fascination, I think one of the main points has been overlooked. Regardless of whether the CDS’s/CDO’s have to marked to market, do these companies deserve a AAA rating? As someone said, “any company that depends on having a AAA rating in order to do business doesn’t deserve one.” If there AAA rating is suspect, then so is the future of their muni insurance business, and hence the future financial health of the companies, regardless of whether or not they have to mark to market in the short term.
February 15th, 2008 at 12:46 pm
Don:
They clearly don’t trade as AAA in the CDS market.
February 15th, 2008 at 12:53 pm
nick:
I haven’t a clue of the status of what was re-insured with Channel RE. Only thing I know is that they marked their equity stake to 0, and last I heard Channel RE still had a triple A rating, don’t ask me why.
February 15th, 2008 at 1:06 pm
[...] as Herb Greenberg feared. Rather, it’s a pretty sober analysis, which seems to have convinced Alea, at least. Here’s one juicy [...]
February 15th, 2008 at 5:56 pm
Wow, this is a an incredibly interesting subject.
I totally agree that MTM accounting on illiquid assets is a terrible idea. But you have to make some estimate of future cash flow losses when assessing their credit ratings, right? If making such an assessment is impossible then the whole idea of stand-alone bond insurers is untenable, and if MBIA and Ambac are destroyed by FAS 133 then good riddance.
February 16th, 2008 at 9:09 pm
JCK,
your analysis is a bit bizzare? Bad mouth ackerman becasue he has a negative view and has followed you advice repeatedly by posting his analysis in an open source forum for peer review. Well the facts, his facts, may indeed be counterfactual fr the past 5 years but he was just early (as were many other in predicting the bust of the housing market). Unfrotunaetly for MBIA he iundeed was able to stay liquid. Therefoee, you analysis is interesting considering you make the same PV argument that MBIA management makes which is counterfactual to every stament by the parties overseeing the process and “solutions.” Whatever you belief in efficient markets, you should be castigating the management of MBIA for their total ineptitude and that of the industry in general in open sourcing their own model so the rumor mongering could have been put to death 5 years ago. Your analysis plays into the old addage show me someone who makes personal attackks and I’ll show you someone losing the debate. Perhaps you could explain why theses institutions are so critical to our financial system? becasue they lower the cost of governement debt? remind me who is on the other side of that trade? unserious post.
February 16th, 2008 at 10:29 pm
s:
I have looked at his analysis and I can confirm that he is talking about futures losses due to defaults and that the current problem of the monolines is due to mark-to-market losses, not defaults.Markto market has no predictive value to estimate losses due to defaults.
His forecast for defaults have been wrong 5 years in a row and counting. Not surprising given his assumptions, for exemple for RMBS he is using deliquencies rates that are 3 to 5 times the worst level ever seen in the U.S.
One of the key factor also ignore by Mr Ackman is that the monolines don’t enter into swaps that require collateral postings so the mark to market losses are an accounting problem and that has NO effect on their liquidity, because there is NO cash movement resulting from the mark to market, it does impair the statutory capital of the insurance company but again on a bookkeeping basis because NO cash is moving or lost. Did Mr Ackman tell you that ?
Don’t think so, he has been busy creating confusion for his own benefit rather than shedding any light on the issues.
But let’s be fair and balanced, even if his analysis is right going forwards, given the form of the contracts that are equivalent to financial guarantees, the monolines remain solvent albeit with an impaired ability to write new business. The present value of the losses under the craziest of scenario is well below the claim paying ability of the major mono.
February 17th, 2008 at 4:45 am
You know, jck is absolutely right. Even with only 1.7% claims paying resources the level of correlation and loss it would take to wipe out MBIA would be enormous. At that Fannie Mae, Freddie Mac, FHA, FDIC, and FHLB would be failing and MBIA and Ambac would be the least of our concerns.
Regulatory arbitrage is what got us into this mess and the only thing that could avoid a deflationary crash is to scrap Basel II, relax Basel I and have a good hard think about whether banking regulations are stabilizing or not.
I say they’re destabilizing in the extreme. What is the point of having a capital cushion if you’re never allowed to sink into it? Inefficient in good times, extremely dangerous in bad times. Companies like GM can sink $41 billion into negative equity and still pay the bills, so it’s ludicrous to put the gun to the banks when their tier-I capital drops below 8%. The floor underneath the banks is harder than any other business yet the externalities to failure are huge.
I fully believe the bond insurers will wind up dead one day and the world will be a better place without them, but first we have to deal with the incentives that created this mess. otherwise the muni bond holders will get to keep their AAA but wake up without a job.
February 17th, 2008 at 2:35 pm
jck
mark to market losses are a function of future losses — in theory they embed future expectations. You may disagree with the embedded asssumptions, but that is neither here nor there. Allso, it is my understanding the premiums are captured upfront, so the “revenu” , if no business is written, is a non cash item as well.
I am not disputing your assertion that we have a TMV issue here. Nor am iinterested in debating “assumptions” since neither of us know what is likley to lay in waste after the deflationary express leaves town. Inthat sense i can see your concern.
As I said minmy post, that he was wrong for 5 years is merely a funtion of him being early to the party but in no way diminsihed the foreesight of his analysis which is plain and simple that these companies are massivily undercapitalized and their bsuiness model is a farse.
You have to love all the free market free press folks who crawl into a hole when the decree the public interest is at stake. The public interest is for these companies to join the ash heap of history. Perhaps itmight force Wall Street to reinvent itself as value added.
February 21st, 2008 at 5:21 pm
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