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Warburg Pincus is calling the bottom. The private equity group’s commitment to inject up to $1bn into bond insurer MBIA comes without the usual safety net. New investors in Citigroup and UBS partially limited their profit potential in return for the protection of a convertible with a high coupon. Warburg, in contrast, is taking super-charged equity.
Its initial $500m investment will feel either the pain of a falling stock price or the full benefits of strong performance. Warburg also gets warrants, exercisable at $40 a share.
If Warburg is right that the equity market has wildly over-reacted to the credit market turmoil, it should make a killing. There was a degree of self-fulfilling prophecy yesterday, with MBIA’s shares jumping 13 per cent to $33.90 on hopes its capital problems are over.
Warburg has also pledged $500m to backstop a rights offering next year. That structure, rare in the US, would give existing shareholders the option of putting up more cash to avoid diluting their stakes.
The private equity firm is right that some markets are pricing in excessively bearish outcomes for the US mortgage market. There is money to be made. MBIA, for example, will get much more profitable terms on bonds it insures in the future. But it has to get through the current turmoil. And huge icebergs are still drifting through the system.
MBIA itself said yesterday that it would establish “case basis loss reserves” of $500m to $800m on a portion of its mortgage-backed securities. That means actual cash losses it expects to incur. It is a huge and uncertain number – especially compared with only $62.5m taken for the first nine months. And it does not factor in any significant cash losses on collateralised debt obligations, in spite of more than $1bn of mark-to-market hits to MBIA’s portfolio in recent months. With such huge numbers in play, Warburg has not left that much margin for error.