Confidence Game - Christine Richard [19]
The revisions continued. “There must be some mistake,” Lyss wrote to Ackman. “We’ve been chopping and chopping, yet this draft is 59 pages long.”
Another week passed. The weekend before the release of the report still found Ackman, Klafter, and Lyss in the office going through the report line by line, noting the source for each statement from more than a dozen boxes of material Ackman had amassed.
After taking a last look at the report, Aaron Marcu, an attorney at Covington & Burling, e-mailed his thoughts to Ackman: “There will be a serious counter-attack by MBIA, as I’m sure you know, and I would imagine that the First Union surprise is part of it. Still, as long as your response is focused on the facts of the report and MBIA’s anticipated failure to dispute them, you will maximize the chances (although not guarantee) that the press reports will be about MBIA and not you. Good luck.”
Finally, Gotham Partners released the 66-page report shortly after 11 a.m. on December 9, 2002. Is MBIA Triple-A? A Detailed Analysis of SPVs, CDOs, and Accounting and Reserving Policies at MBIA Inc. The report didn’t leave much ambiguity about the answer to the question it was posing. “In light of MBIA’s enormous leverage, the company’s credit quality, underwriting, transparency, accounting, and track record must be beyond reproach,” the report stated. “Were the insurance company downgraded by even one notch (from AAA to AA+), even the company acknowledges its business could be materially impaired.”
The Gotham report pointed out that MBIA was levered 139 to 1. The company had guaranteed principal and interest payments on bonds totaling $764 billion and had $5.5 billion of shareholders’ equity, the excess of a firm’s assets over its liabilities. Ackman explained in the report how losses of just $900 million—a sliver of the $764 billion in outstanding MBIA-insured debt—could lead to the company being downgraded.
Problem credits are larger than investors realize, the report said, because MBIA hadn’t publicly disclosed how many bonds had been restructured to prevent a default. These transactions, Gotham stated, may only serve to defer losses into the future.
The Gotham report noted an unusal reinsurance transaction that had allowed MBIA to avoid booking a loss on a hospital’s bonds after the health-care organization filed for bankruptcy. Under these reinsurance contracts, several insurers agreed to reimburse MBIA for its losses in exchange for guaranteed reinsurance business in the future. To Ackman, the deal looked much more like a loan than reinsurance. If it were accounted for as a loan, then MBIA would have had to take a large loss. The predictability of MBIA’s earnings was one factor that supported its triple-A rating. We “believe that this mechanism is not in fact reinsurance but rather a loss-deferral, earnings-smoothing device,” Gotham stated.
MBIA’s special-purpose vehicles (SPVs) were featured prominently in the report. Although the company never disclosed what assets it funded through the SPVs, Gotham had been able to identify about half of the $8 billion in loans. Companies selling assets to the SPVs included Onyx Acceptance Corporation, which made loans to credit-impaired borrowers to purchase used cars, and American Business Financial Services, a company that originated home-equity loans in the subprime market.
Gotham also pointed out that MBIA was now entering into credit-default-swap (CDS) contracts as a way to guarantee collateralized-debt obligations (CDOs), despite a New York state prohibition on bond insurers backing derivatives. “LaCrosse transforms obligations that MBIA cannot guarantee directly into ones it believes it can guarantee indirectly,” the report said. A statement in MBIA’s most recent filing with the New York State Insurance Department, saying the company has not entered into any transactions classified as derivative instruments, “obscures the company’s true credit derivative exposure,” the report said.
Ackman also disclosed the mark-to-market estimate he obtained for MBIA’s credit