We are downgrading our recommendation on the shares of MBIA Inc. (MBI) to Underperform as macroeconomic conditions continue to contribute to losses on the group’s structured finance products.
MBIA insures mortgage-backed securities backed by subprime mortgages. MBIA also has an indirect exposure to subprime mortgages that are included in collateralized debt obligations (CDOs), in which the company has guaranteed the senior most tranche of such transactions. There has been considerable stress and continued deterioration in the subprime mortgage market since early 2008 and in 2009, reflected by delinquencies and losses, particularly related to subprime mortgage loans originated during 2005 to 2007. The increase in delinquencies has been negatively affecting the company’s results. We do not expect a reversal in the trend until the second half of 2010.
MBIA has been facing rating downgrades for quite some time. Once the strongest of the bond insurers the company has been downgraded by the rating agency Standard & Poor’s, to BB- from BB. The company’s principal bond insurance unit, MBIA Insurance Corp., was downgraded to BB+ from BBB, which is considered non-investment or junk status. The ratings carry a negative outlook. The rating agency is of the opinion that losses on residential mortgage-backed securities and collateralized debt obligations that MBIA guaranteed from 2005 to 2007 could be higher than expected.
The adverse rating actions by the major agencies throughout 2009 have hurt MBIA Corp’s ability to attract new financial guarantee business. As a result, the company’s market share decreased to approximately 2.2% in 2008, compared to approximately 23.0% in 2007. Additionally, MBIA Corp. did not underwrite any non-U.S. public finance transactions in 2009 due to its previously announced decision to suspend the writing of all new structured finance. The structured finance industry offers very little new business opportunity; it is still quite uncertain when or how MBIA Corp may re-engage in this market.
However, positives include the move by MBIA to separate its riskier business of insuring structured financial obligations from the traditional bond insurance by capitalizing National Financial Guarantee Corp during Feb 2008. National Financial provides MBIA with a greater resilience and financial flexibility because we expect it to enable MBIA to resume writing financial guarantee insurance in the domestic public finance sector. The establishment of National Financial is expected to generate the writing of new business in the active U.S. public finance market once high stable ratings are achieved for the operating subsidiary, leading to increased profitability and additional sources of liquidity for MBIA.
Due to the long-tailed nature of the financial guarantee business, it is important to note that -– even without regard to any new business –- the company will have a steady stream of scheduled premium earnings with respect to its existing insured portfolio. The company’s exit from the insurance of credit derivatives will not have any impact on the expected earnings related to the existing insured portfolio (i.e., the back-book business).
With fourth quarter results likely to be released on March 1, 2010, the Zacks Consensus Estimate is for a loss of $1.19 per share.
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