MBIA case study

An overview of Ackman's case against MBIA

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    Overview of MBIA

    • MBIA was founded in 1973 as the Municipal Bond Insurance Association and is currently the largest bond insurer. 
    • When MBIA insures a bond they are guaranteeing the scheduled payments of interest and the principal. As compensation MBIA charges a premium. Having bond insurance lowers the borrowing cost for the issuer by lowering the risk on the bond. In a sense, bond insurers sell their AAA credit rating to issuers. The only risk that remains is if the insurance company goes bankrupt, therefore it is extremely important that bond companies have the highest possible credit rating. 
    • In MBIA's case, they admitted in 2001 that if they were to be downgraded by one notch, (from AAA to AA+6) their business could be materially impaired. 
    • MBIA was one of the first company to offer bond insurance on municipal bonds. 

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    Bill Ackman

    Bill Ackman was born son of Lawrence David Ackman a chairman of a New York real estate financing firm.  He received a Bachelor of Arts and magna cum laude from Harvard College and MBA from Harvard Business School.  In 1992 Ackman created Gotham Brothers with a fellow Harvard graduate.  In 2003 he was investigated and no wrongdoing was found.

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    Gotham's original report against MBIA

    MBIA operates its insurance subsidary, MBIA Insurance Corp. The insurance company's AAA rating is critical to the success of the entire enterprise/. Were the insurance company dongraded by even one notch, even the company acknowledges its business could be materially impaired.

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    Short Story of MBIA

    <a href="http://video.cnbc.com/gallery/?video=1478845130" target="" rel="">http://video.cnbc.com/gallery/?video=1478845130</a><br>

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    High Leverage

    At the end of September 2002 MBIA had $5.5 billion of shareholders' equity supporting $764 Billion of outstanding guarantee liabilities. That means each $1 in equity supporting $139 in liabilities. 

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    Credit Default Swap (CDS)

    "A swap designed to transfer the credit exposure of fixed income products between parties. A credit default swap is also referred to as a credit derivative contract, where the purchaser of the swap makes payments up until the maturity date of a contract. Payments are made to the seller of the swap. In return, the seller agrees to pay off a third party debt if this party defaults on the loan. A CDS is considered insurance against non-payment. A buyer of a CDS might be speculating on the possibility that the third party will indeed default."

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    CDO: Collateralized Debt Obligation, is a pool of interest paying assets, such as mortgages, bonds, and loans, that can be cut into pieces by risk classes and sold to investors. MBIA guarantees CDOs for a premium, although they originally only guaranteed low risk CDOs they began to expand coverage to riskier CDOs in 2000. Since the collateral for these CDOs were normally risky assets (such as subprime mortgages) Ackman believed the rating agencies overlooked these and MBIA was more risky than appeared. There is also some accounting issues, MBIA didn't have to disclose exactly what was in the individual C.D.O.'s that they insured. 

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    Special Purpose Vehicles (SPVs)

    SPV's or Special Purpose  Vehicles are subsidiaries of companies that have their own financing.  Many SPV's are used to limit risk from the parent company to the SPV so that if the project of the SPV goes bad then it will not take the whole company down.  Bill Ackman believed that MBIA was using SPVs to hide much of the risk that the company was actually taking.

    MBIA had almost $9 billion of assets and liabilities in five off-balance sheet special purpose vehicles. These were supported by only $125,000 in third party equity. Ackman believed a decline in MBIA's credit rating would cause the SPV's assets to be less than their liabilities. 

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    Ackman's Greatest Short Ever Told Began With Handshake Refused

    March 24 (Bloomberg) -- As the taxi pulled away from Grand Central Station on a late November afternoon in 2002, Bill Ackman was bracing for a fight. The 36-year-old co-founder of a hedge fund firm called Gotham Partners LP in New York had been summoned to a meeting with Jay Brown, the chief executive officer of MBIA.

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    Bloomberg's Richard Discusses Ackman's Bet Against MBIA: Video

    March 24 (Bloomberg) -- Bloomberg's Christine Richard talks with Deirdre Bolton about her new book "Confidence Game: How a Hedge Fund Manager Called Wall Streets Bluff," which details hedge fund manager William Ackman's prescient bet against MBIA Inc. five years before the worst financial crisis in decades. (Source: Bloomberg)

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    MBIA Stock Price Timeline

    A timeline comparing the stock prices of MBIA and the S&amp;P 500 index.

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    RyKnow shared a chart on StockTwits

    Not a defender of Ackman. Point of this chart is sizing/weighting is more important than timing. http://stks.co/aze9

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    Ackman Devoured 140,000 Pages Challenging MBIA Rating

    Jan. 31 (Bloomberg) -- It was the $109,000 photocopying bill that hedge fund manager William Ackman says made him realize how much he'd read and underlined before betting against bond insurer MBIA Inc. in 2002. His law firm charged him for copying 725,000 pages of financial statements and other documents, 140,000 of them about MBIA, to comply with a subpoena.

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    Short Seller Sinks Teeth Into Insurer

    This article overviews Ackman's relentless attempts to try to persuade people to believe MBIA did't deserve it's AAA rating in the years after 2002. He talked to the S.E.C., the NYS Insurance Commission, and the NYS attorney general. He also held meetings with Moody's, Standard &amp; Poor's, and Price Waterhouse Coopers. Many people on Wall St. criticized Ackman, they say his attacks were an effort to undermine the confidence of MBIA's ability to insure bonds. In this was Ackman was trying to enact a self-fulfilling prophecy, if confidence in MBIA is undermined since people believe they will go bankrupt then the company will go bankrupt.&nbsp;

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    Ackman's Letter to Moody's

    Each of you, according to your recent public statements, is in various stages of updating your ratings of the bond insurers. Unfortunately, however, your previous ratings assessments have erred materially in their omission of certain critical analysis and the inclusion of outright errors in your work. As you conduct your most recent revisions of your analysis on the bond insurers, it is vital that you conduct a thorough assessment of all aspects of the bond insurers’ business lines, their reinsurers, and investment portfolios so that the rating decisions that you ultimately publish can be relied upon by capital markets participants.

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    Credit Rating Decreases

    On April 4, 2008 Fitch cut MBIA's credit rating to AA despite MBIA asking Fitch not to rate their credit anymore.  Then on June 4, 2008 Moody's announced that it would review MBIA's credit rating.  On June 6, 2008 S&P announce that it changed it's rating from AAA to AA.  On June 19, 2008 Moody downgraded MBIA from Aaa to A2.  On November 7, 2008 Moody futher downgraded MBIA to Baa1.  On June 25, 2009 MBIA was further downgraded to Ba1 which is  a speculative grade.
    June 2009: Moody cuts to speculative grade

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    Jay Brown's big MBIA mess

    MBIA breaks up the company into two separating companies. Jay Brown the CEO of MBIA tries to sue investment banks for hiding risk of MBS, mortgage backed securities that they insured. As an example, MBIA claims that of the 4,700 loans it insured from Countrywide, and later defaulted, 91% lacked verification of income or had invalid appraisals.&nbsp;

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    Ackman's position

    Bought credit-default swaps against $2 Billion worth of MBIA debt. 

    Short positions on MBIA stock

    He went short around $45 and covered around $4.

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    Business Policy Shelf

    These are all the toolsets you will need for this semester.

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