Below is a copy of the letter Bill Ackman sent to Moody's rating agency regarding MBIA (MBI) and Ambac (ABK). Marty Whitman can call him what he wants, but the guy knows his stuff.
January 18, 2008
Mr. Raymond McDaniel Mr. Stephen Joynt
Executive Chairman and CEO CEO and President Moody’s Corp. Fitch Ratings
99 Church St. One State Street Plaza
New York, NY 10007 New York, NY 10004
Mr. Deven Sharma
President
Standard & Poor’s
55 Water Street
New York, NY 10041
Re: Bond Insurer Ratings
Ladies and Gentlemen:
As a Nationally Recognized Statistical Rating Organization, Moody’s, S&P, and Fitch have been granted a level of authority that capital market participants and Federal and State regulators have historically relied upon in evaluating the safety and soundness of corporations, regulated financial institutions, and structured finance securities. To state the obvious, because of your critical role in the capital markets, it is essential that the ratings you publish are the result of comprehensive and accurate analysis.
As you well know, we have privately, in meetings and correspondence with you, and publicly in various presentations that we have made, called into question your ratings of the bond insurance industry, in particular, the ratings for MBIA Insurance Corp. and Ambac Assurance Corp. and their holding companies.
Each of you, according to your recent public statements, is in various stages of updating your ratings of the bond insurers. Unfortunately, however, your previous ratings assessments have erred materially in their omission of certain critical analysis and the inclusion of outright errors in your work. As you conduct your most recent revisions of your analysis on the bond insurers, it is vital that you conduct a thorough assessment of all aspects of the bond insurers’ business lines, their reinsurers, and investment portfolios so that the rating decisions that you ultimately publish can be relied upon by capital markets participants.
Below we highlight a number of factors that you have failed to consider in your prior assessments of the bond insurers’ capital adequacy:
1) Impact of Losses Should be Measured on a Pre-tax Basis
We believe that each of you overstates the bond insurers capital cushion due to tax benefits you include in calculating the impact of RMBS and CDO losses. For instance, in S&P’s recent press release update published yesterday, MBIA’s losses on RMBS and CDOs are expressed as “after-tax” losses. In order, therefore, to determine the actual cash losses implied by S&P’s after-tax estimate, one must gross up the reported $3.18 billion of after-tax losses. Assuming a tax rate of 38%, it appears that S&P is estimating MBIA’s actual cash losses at $5.13 billion, nearly $2 billion more than the losses adjusted for tax benefits.
Insurance claims must be paid in cash. A bond insurer is only able to obtain tax benefits if the insurer is a going concern and is able to generate sufficient taxable income in the current or future years to offset the losses from paid insurance claims. Your analysis makes the aggressive assumption that the bond insurers will remain going concerns and will therefore be able to continue to write new premiums and generate income in the future.
Based on recent industry developments – including Berkshire Hathaway’s entrance into the business – it appears unlikely that MBIA, Ambac and many of the other bond insurers will be able to continue as going concerns. In a runoff scenario, we do not believe that the bond insurers will generate sufficient taxable income to offset the net operating losses generated by paid losses. While U.S. corporations can receive tax refunds by carrying back tax losses up to two calendar years, the amounts that could be refunded from carrying back losses are de minimis relative to claims payable. Even in the event the bond insurers generate taxable income in future years, it may be many years before these tax benefits can be realized, if ever, particularly in the event of corporate ownership changes caused by capital raising or stockholder turnover.
Net operating loss carryforwards are not cash and are not available to pay claims and should therefore not be deducted from losses in calculating bond insurer capital adequacy. By using after-tax loss estimates rather than pre-tax losses – the amount that will need to be paid in cash – you are understating the actual losses payable by more than 60%.
Your updated rating assessments should be adjusted to exclude tax benefits in your calculation of capital adequacy
2) Covenant Violations and Loss of Access to Liquidity Facilities
As a result of recent losses, both MBIA and Ambac have triggered covenant violations on their liquidity facilities. As a result, Ambac has lost access to $400 million of funding and MBIA to $500 million of capital. The impact of the loss of these facilities is material to the liquidity profile of the holding companies and their insurance subsidiaries and must be considered in your credit assessment.
3) Loss Estimates Must Incorporate Reinsured Exposures
Your ratings of the bond insurers are based on the bond insurers’ net credit exposures. That is, you reduce their credit exposure by those exposures that have been reinsured. This is best understood by example.
As of September 30, 2007, MBIA has re-insured approximately $80 billion of par value
of its exposures. More than $42 billion of this reinsurance was purchased from Channel Re, a Bermuda- based reinsurer whose only customer is MBIA. The two most senior officers of Channel Re are former executives of MBIA. MBIA owns 17% of the company and has two representatives on Channel Re’s board of directors.
On recent conference calls, Moody’s and S&P have stated that they have not yet updated their ratings of the monoline reinsurers including Channel Re. Earlier this week, on January 16th, Partner Re and Renaissance Re, the majority equity owners of Channel Re, wrote off the entire value of their investments in Channel Re due to losses it has recently incurred that substantially exceed Channel Re’s capital, an impairment that Channel Re’s two majority owners have concluded is “other than temporary.”
Despite the fact that Channel Re has negative book equity and $42 billion of MBIA’s credit exposure – $21.5 billion of which is CDOs of ABS or CLO/CBOs – Moody’s and S&P continue to rate the company Triple A with a stable outlook. Fitch does not rate Channel Re and apparently relies on S&P’s and Moody’s stale Triple A ratings in its
analysis of MBIA’s capital adequacy.
Captive reinsurers whose ratings are not regularly updated offer the potential for abuse.
We believe that MBIA reinsured on a quota share basis 25% of its 2007 CDO transactions with Channel Re. As a result of Moody’s and S&P not updating its ratings of Channel Re, these exposures do not appear on MBIA’s list of exposures and have not been included in your calculation of MBIA’s capital adequacy.
MBIA’s second largest reinsurer is Ram Re which has reinsured $11 billion of par as of September 30, 2007. While the rating agencies have not updated their credit ratings of Ram Re, the market appears to have already done so.
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