An Open Letter to MBIA Management. Start Spinoff Preparations Now

Now that the transformation litigation, challenging the separation of the municipal finance guaranty business of National from the securitization guaranty business of MBIA Insurance Corp, has been dismissed, it is time for MBIA to take the next step:  spinoff either National or MBIA Insurance to complete the structural separation of their separate businesses, and forever separate their disparate risk profiles and respective shareholder bases.

The investment merit of a spinoff at MBIA is obvious and recognized by MBIA management.  Recently, MBIA CFO Chuck Chaplin stated in an interview with BTIG analyst Mark Palmer that he appreciated the thinking of those who argue that the natural owners of National and MBIA Insurance Corp. over the long run may be different types of investors.  “I’m open to that argument,” he said. “When you have two businesses with very different risk and payoff profiles, the way to maximize value may be through a spin, or tracking shares, or other permutations. “It’s too early to say that is the case, but I could see it happening.”

Agreed.  But then, Mr. Chaplin said something that strikes me as dead wrong:  “At this point we think that the value of National can be maximized without separating it from MBIA Inc.,” he said.  As for the spinoff, Mr. Chaplin said that "it’s not something that we’re contemplating at this time."

This seems dead wrong to me for at least three reasons.

First, from an investor's standpoint, it seems clear that the intrinsic valuation of National is being punished by its corporate association with MBIA Insurance.  In my view, one can easily make the case that the standalone valuation of National is $16 per share, and I would assign a $2 per share valuation to MBIA Insurance (especially given that MBIA Insurance expects to receive approximately $4 per share by the end of the year in respect of its claims in the ResCap bankruptcy.  Remember, the inter-company loan to National as been paid off; the entire ResCap recovery stays at MBIA Insurance).

The reality is that the market is applying a negative valuation to MBIA Insurance, assigning about a $2 discount to National, because an investor in National must also be an investor in MBIA Insurance.

If you think about it, this is not an unreasonable investment position for an investor interested in National.  Most investors with an interest in municipal guaranty insurance have developed a well-deserved antipathy to securitization guaranty insurance, given the financial crisis events of the past five years.  Why should an investor in municipal finance necessarily make a bet on the prospects of a continued housing recovery, which is an important valuation criterion relating to MBIA Insurance?  MBIA is forcing this bet on a National-centric investor, and for this the National-centric investor is extracting a discount.

Second, the valuation of National is directly related to the creditworthiness rating assigned to National by the rating agencies, and Moody's has already gone on record as saying that it views MBIA's common ownership of National and MBIA Insurance as a negative for National's rating.  Moody’s analysts Helen Remeza and Stanislas Royer explained that “while National’s insured portfolio is expected to generate losses that are well covered by its claims paying resources, its business position is characterized by a lack of participation in the market for the last five years, and by its continued affiliation with the much weaker MBIA Corp.”

As National eventually starts to write municipal guaranty insurance again, the first concern expressed by Moody's will be addressed over time.  But this second Moody's concern, continued affiliation with MBIA Insurance, can only be addressed by MBIA management proactively by means of a spinoff and, for the reasons I set forth below, preparations for such a spinoff should start now.

So, irrespective of whether you think National should be tainted from a ratings point of view by being a sister affiliate of MBIA Insurance, it is hard to reconcile this ratings agency mindset with Mr. Chaplin's view that National's value is maximized by maintaining the current corporate structure.

Third, the remaining mbs representation and warranty (R/W) recoveries that MBIA Insurance can expect to recover will have a far greater positive valuation effect upon an isolated MBIA Insurance than upon the current MBIA capital structure.  This is true not only because the recoveries will represent a much larger percentage of the enterprise valuation of MBIA Insurance on a standalone basis, but also because the shareholder base of a standalone MBIA Insurance will be better able to assess the litigation valuation prospects of these R/W actions than an MBIA shareholder base that comprises primarily municipal finance investors.

I strongly believe that the lackluster performance of MBIA's stock price since the Bank of America (BAC) settlement illustrates the dysfunction of MBIA's continuing with a mixed shareholder base of National-centric as well as MBIA Insurance-centric investors. Selling in MBIA shares has likely been done by investors who were willing to become shareholders of MBIA to participate in an MBIA Insurance victory against BAC, but not willing to remain investors in the combined MBIA Insurance/National enterprise post settlement.  Put another way, I might believe that given the magnitude of MBIA's claims in the BAC litigation, I am willing to be an MBIA investor to participate in an MBIA Insurance litigation payoff before the BAC settlement, but the future prospects of MBIA Insurance in respect of the remaining R/W actions, in particular, and in the potential continuing housing recovery, in general, are not sufficient for me to be diluted as an investor in National as well. Certainly, Fairholme's selling of over 40 million MBIA shares post BAC settlement illustrates this notion.

Separating MBIA Insurance will not only improve National's valuation, but it may presage a resumption by MBIA Insurance of its securitization financial guaranty business.  One can expect that securitization transactions will reemerge over time, as the need is too great given the supply of commercial and residential real estate loans and the investment demand for yield.  One can see that transactions such as the one recently announced by Shellpoint Partners, which do not involve a sunset of R/Ws and in which the originator maintains an investment position in the pool, may become a template for not only a resuscitated securitization market, but also one in which guaranty insurance can reappear.  What will be good for National in isolating its shareholder base may also become good for MBIA Insurance.  If MBIA Insurance requires additional capital in order to resume its business, common ownership with National will only lead to further discounts to National's valuation.

Spinoffs are complicated transactions that require substantial lead time.  The to do list is long, and the transaction needs to conducted with care. 

• Financial and legal advisors must be retained to analyze and propose the best structure and transaction pathway. 
• The New York Department of Financial Services (NYDFS) will have to approve the transaction, and any NYDFS comments may require structuring and financial adjustment.  
• MBIA may need to conduct a refinancing of its holding company debt in connection with a spinoff.  
• The tax-free characterization of the transaction needs to be nailed down, and a private letter ruling from the IRS likely needs to be obtained.
• Proxy statements and solicitations need to be filed and conducted.
• A road show addressing the merits of the spinoff needs to be conducted by MBIA management.

 I have great respect for MBIA management.  But now it is time for MBIA management to get on the stick and start preparations for a spinoff.

NB:  this blog is not intended to be investment advice, and should not be relied upon by anyone to constitute investment advice.  Investing is a tough game, and everyone must do and "own" their own work, because you will certainly own your investments.

Disclosure: long MBI  Follow me on twitter.