Is it possible to look at a long-term chart of MBIA these days and not feel a slight twinge of motion sickness? Possible, but not easy: the stock has fallen to single digits lately, from the upper 60s just last October. And over that time, it’s sparked one of the highest-profile investment controversies Wall Street has seen in recent memory. On the one hand are the bears, led by Wall Street’s version of Barack Obama, Bill Ackman, and his amen chorus at CNBC and Bloomberg. He says losses in mortgage-backed securities and CDOs the company has guaranteed have rendered it “insolvent,” and has come up with some colorful, rigorous-looking ways to make his point.
The bulls, meanwhile (who include Third Avenue’s Marty Whitman, Chris Davis, as well as us) believe that not only is the company not insolvent, it is ridiculously overcapitalized, and will emerge from the subprime crisis in a very strong competitive position.
This is exactly the sort of situation, you are saying to yourself, in which sell-side analysts can add some real value in sorting out—and help their clients make some money along the way.
Wrong! Despite the controversy and the huge potential money to be made in MBIA, most major Wall Street firms have basically taken a powder. Formal coverage is by now thin on the ground. Incredibly, all the analysts who still cover MBIA have it rated the equivalent of “market perform.” Trust me, if there’s one stock that’s not going to be a market performer over the coming twelve months, it’s MBIA!
The sparsity of coverage is astonishing. MBIA’s market cap today comes to $2.3 billion--yet only six sell-side analysts see fit to spend the time and energy to calculate earnings estimates and publish reports on it. To put that in perspective, First Horizon, a banking company with credit problems of its own, has a market cap of $2.1 billion and is covered by 19 analysts.
I mention all this because the Street’s reaction to MBIA’s second quarter earnings, which were out last Friday and were spectacularly strong, was notable in its refusal to admit some compelling, obvious facts: the fundamentals at the company were much better than they expected, losses and impairments have peaked, and the company is on the road to recovery.
In particular, the company reported second quarter operating earnings of 96 cents per share, compared to a consensus expectation, according to Bloomberg, of a loss of $1.23 per share! None of the six expected the company to even turn a profit.
If this were any other industry than the financial services industry in 2008, the quarter would have been described as a “blowout.” So what did the sell-siders have to say? They could barely stifle a yawn. One of the six hasn’t even written a word. Four have published cursory, one-page notes. The sixth wrote a note that came to all of three pages.
Their conclusions are as wishy-washy as they were short. Here’s a sample:
Brian Meredith, UBS: “ Operating EPS of $0.96 above consensus ($0.96) and our estimate ($2.76)”
Monica Gabel, Goldman Sachs: “Uncertainty about ultimate losses and rating agency actions remain high; we maintain our neutral rating.”
Steve Stelmach, Friedman Billings: “We are maintaining our market perform rating and lowering our price target from $13 to $10 to reflect ongoing uncertainty over the company’s business prospects.”
Gary Ranson, Fox-Pitt Kelton: “While the company is making progress in stabilizing its business, we continue to believe the road to recovery will be a very long one.”
Darin Arita, Deutsche Bank: “Although there could be significant upside or downside to the stock, our hold rating reflects uncertainty on the potential for large losses, future business prospects and additional capital needs.”
Do you get the sense that the last thing these people want to do is take an actual stand on the company? But they’re making a huge mistake. In my view, MBIA’s second-quarter report strongly supports the bulls’ view that this is one of the most undervalued financial services company in the market today. The numbers were spectacular, and not just because they blew the bottom-line consensus estimate to smithereens. Here’s why:
1. The company booked no new reserves or impairments on its residential mortgage-backed securities (RMBS) or collateralized debt obligation (CDO) exposures. This after having boosted reserves and impairments for the last three straight quarters. That’s key, since the second-quarter numbers validate the revised credit analysis the company did in the first quarter, when it assumed added deterioration in the performance of the bonds it’s insured.
2. The company didn’t change its estimate of “stress” case losses. MBIA had earlier taken $1 billion of impairments on its multisector CDO exposure and $1.1 billion of reserves on its RMBS guaranties. When the company announced first-quarter earnings, it said it estimated that in a stress case, CDO impairments could reach $2 billion and reserves for RMBS could reach $1.7 billion. It’s incredibly positive now that the company didn’t see anything in incremental credit performance that would cause it to change either its base case or stress case loss assumption. This is in sharp contrast, by the way, to the expectations of the few analysts that cover the company. For example, Goldman Sachs’ 2009 earnings estimate for MBIA assumes an additional $7 billion of reserves and impairments. Yet despite the company’s strong second-quarter credit performance, the Goldman analyst didn’t lower her 2009 loss forecast. I suspect it’s just a matter of time before the number comes down significantly.
3. The company didn’t reverse prior reserves in anticipation of recoveries on guaranteed loans found to be fraudulent. There is no doubt that MBIA will see substantial recoveries as a result of this so-called “remediation” process. In its second-quarter report, another large guarantor did reverse some reserves for this very reason—and I have no problem with that. But MBIA is being especially conservative by waiting until the timing and magnitude of such reserve releases becomes more certain. The numbers don’t figure to be small. In the quarter, MBIA sent out put-back notices to underwriters that totaled $300 million.
4. The company’s CDO exposure fell by $5 billion, including a $1 billion reduction in high-risk, multi-sector CDO exposure. The exposure reduction occurred as a result of amortization and commutation. Especially impressive is the fact that that the company incurred no loss—zero—related to the reduction, including the reduction on the multi-sector CDO exposure. This supports management’s belief that superior structuring can and will continue to mitigate losses.
5. MBIA’s claims-paying ability remains over $15 billion. Remember, the company has $2.1 billion in reserves and impairments related to its RMBS and CDO exposure. Its stress case estimate comes to $3.7 billon. This compares quite favorably to its current claims-paying of over of $15 billion. Let me do the math: the company’s claims-paying ability is over four times larger than its stress-case los estimate!
6. MBIA’s insurance subsidiary has excess capital relative to its current ratings. That $15.2 billion in claims-paying ability, based on Moody’s definition, exceeds the $14.7 billion Moody’s requires for a Aa rating, and far exceeds the $11.9 billion required for the company’s current, A, Moody’s rating. On S&P’s methodology, MBIA now has $400 million in excess capital relative to a AAA standard, $3.5 billion in excess relative to a AA (which is what S&P rates MBIA now), and $7.4 billion in excess relative to an A. The rating agencies, who have been the true lunatics throughout this whole credit mess, have made it clear in recent months that factors other than capital strength figure in their ratings decisions. I have long ago given up figuring out rating-agency “logic.” Even so, it’s hard to believe claims-paying ability isn’t paramount in determining a guarantor’s financial strength. It’s hard not to be impressed with how much above the minimum standards MBIA is.
7. The company has built sufficient liquidity in its asset/liability products segment. MBIA sold $7.5 billion of securities in the second quarter, and has since sold an additional $3.2 billion in the third quarter. Why’s this important? It gives the company all the counterparty-related liquidity it will need should the rating agencies (the scoundrels!) decide to downgrade the company’s debt further. Worries about downgrade-related liquidity pressure have been a particular bugaboo of Bill Ackman. It is now a non-issue. I assume that at some point he’ll acknowledge this.
8. The company announced a resumption of its share buyback program. MBIA raised a ton of new equity earlier this year in an effort to retain its AAA rating. Now that the company’s been downgraded anyway, MBIA finds itself with substantial excess capital relative to its current insurance company ratings, and $1.2 billion in cash and short-term investments at the holding company. Given this, MBIA’s board authorized the resumption of a share repurchase program that will allow it to buy back $340 million in stock. I expect the company to be prudently aggressive in carrying the program out, given the stability of credit and its dramatically depressed stock price. At an average purchase price of $10 per share (the stock’s at $8.50 now), the $340 million remaining on the authorization could result in 12% of outstanding shares being repurchased. And remember, this would still leave the holding company with $800 million in cash and liquid investments!
9. Operating earnings were 96 cents per share. Don’t forget, the company was solidly profitable on an operating basis. If you annualize the 96 cents MBIA earned last quarter, the stock is trading at 2.2 times its current run-rate of earnings.
The analysts (and short sellers) continue to believe management significantly underestimates the need for additional reserves and impairments on MBIA’s RMBS and CDO exposure. I believe this view will gradually change as the monthly mortgage servicer reports continue to be released and show that credit is now deteriorating at a much more moderate pace than it was last fall. The pig (that is, poorly underwritten and fraudulently secured loans) is steadily moving through the python.
The other concern is that the company is not writing any new business. I don’t see this changing until the rating agencies become rational again. But I don’t see why it’s a concern. MBIA doesn’t need to write a dime’s worth of new business, and its stock can still deliver an outstanding return; its current stock price of $8.50 is just 19% of the company’s “adjusted” book value $43.63!
Now, reasonable people can come up with different estimates of what the company’s adjusted book value is, but any fair analysis will result in a number over $30 per share--so the gap is still huge!
MBIA will be a leader in the financial stock bull market
MBIA made underwriting mistakes, which it has acknowledged. But I believe management has aggressively analyzed its book of business and has recorded adequate reserves and impairments. This is one of the most undervalued financial services companies around, in my view; I believe it will be one of the leaders in the financial stock bull market that began July 15th.
And yet, tellingly, no one will acknowledge the huge change in the company’s fundamentals. The media shows no signs of pulling back on its fawning treatment of Bill Ackman. And, as we’ve seen, the people who are paid to follow the company and write about it—sell-side analysts—apparently have no interest in doing anything but superficial work. That’s the way bottoms work. Don’t worry, once MBIA has tripled, the sell-side will start to raise ratings—and the people at CNBC will find someone else to take Bill Ackman’s place on their pedestal.
What do you think? Let me know!