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MBIA (MBI)
Why MBIA Splitting Itself can be Good
MBIA announced Wednesday morning that it would be splitting itself into two units. The first unit will focus on international and structured finance, while the second unit would focus on municipal bonds as a public finance bond insurance company. Investors were optimistic about this move and sent shares higher by 39 percent. As the early trading session continued, however, shares in the firm's stock reached as high as $4.93 but quickly staggered off. In fact, at the lowest trading point this morning, it fell down to $3.51. With such sharp spikes like this, should investors really believe that splitting off into two units was smart?
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Yes and no. First off, this move would create new customers for the company, which would result in new cash flows and potential growth. Second, business in municipal bonds will not be affected by activities from the more complex world of structured finance. Therefore, if another subprime-mortgage catastrophe occurs, the separated division could continue doing business as usual and continue seeing profits. They also plan to capitalize the new unit with lots of money beyond what is historically required of AAA ratings. CEO Jay Brown mentioned that they want to raise third-party capital without diluting existing shareholder wealth. Perhaps this means the company will be more aggressive in getting government assistance, though no federal aid has been received yet.
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Dividing up the firm is far from error-free though as the move raises plenty of concerns. Structural questions come immediately to mind, including who will lead the new division. The S&P credit rating agency went so far as to downgrade MBIA's main insurance business to BBB+ and mentioned that the new unit had "uncertain business prospects." After all, when they lost their credit rating, they were no longer able to write new muni-bond insurance which resulted in rivals like AMBAC (ABK: Charts, News, Offers) taking some of MBIA's market share. That aside, nothing has really changed for the company. They still run the same mix of businesses with the same clients in the same manner. Can we really expect them to see more value by just drawing a line between the businesses? The company and its investors think so, though credit rating agencies are on the other side of the coin on this one.
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Was this a move to split up the good assets from the bad assets? Mr. Brown says no. Currently, the financial giant manages about $537 billion in municipal debt. The sheer size is enough to justify being broken apart. Furthermore, Mr. Brown stated in his letter to shareholders that MBIA still has the ability to pay all expected claims in the future. Whatever the original intention though, it will still result in a "good bank/bad bank" type of split. Just look at the credit ratings leading up to this. The company lost its AAA rating in June 2008, and currently, the firm is rated three notches above "junk" status. This severely limits their ability to write bonds because investors will not be as likely to purchase them. Splitting up may allow the new division to reach a higher credit rating of AAA and generate more business, while the other would undoubtedly fall because it no longer has the credit worthiness afforded by the muni-bonds. Therefore, the net effect will still be akin to a good bank/bad bank separation.
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The new unit will eventually be called National Public Finance Guarantee Corporation and operate from New York. None of the company's units will rely on credit default swaps or derivatives anymore as Mr. Brown states they made the firm's financial statements too volatile. He also mentioned that despite the recent downgrade, the embedded book value was still around $40 per share. Still, it will take time for the division to realize new customers. If they can however, then now would be the time for value investors to buy if they anticipate growth in the future and agree with this statement.
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