2nd UPDATE: Fitch To Keep Rating MBIA Despite Its Protests

Last Update: 3/10/2008 7:10:27 PM

By Alistair Barr

In the latest salvo in a now highly public war of words, ratings agency Fitch
said it will continue to rate MBIA Inc.’s (MBI) subsidiaries without charge,
despite the bond insurer’s request that it stop.

The increasingly confrontational dialogue was initiated on Friday when MBIA asked
Fitch in a letter to stop providing some ratings on the firm. That letter,
released to the public, also asked Fitch to return or destroy data MBIA had
provided to Fitch.

MBIA Chief Executive Jay Brown defended the firm’s decision and said the company
has started to generate new business.

In response, Fitch CEO Stephen Joynt said the agency plans to keep rating the
bond insurer and questioned the company’s reasons for trying to end their
relationship.

“It seems disingenuous at best to assert in your letter to investors published
yesterday, March 9, that you ‘intend to work with Fitch to perform the analysis
needed to rate MBIA’s debt securities,’ while privately demanding return of the
portfolio information and materials that you freely provided to support our
ratings and that of other rating agencies for many years,” Joynt wrote.

MBIA shares fell 10% to $10.77 on Monday, leaving them down 29% so far this year.
The 52-week high was $72.38 set in April.

Fitch’s decision to keep rating MBIA is a positive development, according to
Joseph Mason, associate professor of finance and LeBow Research Fellow, at Drexel
University’s LeBow College of Business.

“This is the kind of market discipline we need to get back to,” Mason said.
“Before the 1970s, there was a very prevalent traditional of unsolicited ratings.
This kept the agencies that get paid to do the ratings in line.”

Most ratings agencies are paid by the companies they analyze. That’s created the
perception of a conflict of interest because agencies may be less inclined to
come out with lower ratings because they don’t want to upset the firms that pay
them.

If more agencies rated companies without being paid by them, this potential
conflict could be reduced.

“Unsolicited ratings allow agencies to demonstrate their abilities, even when
they don’t have any monetary interest in the outcome,” Mason said. “Any bias gets
washed out of the system pretty quickly. Right now that bias is in the system.”

Ratings agencies also get confidential information from companies to help them
produce more accurate ratings. But when companies restrict information to some
agencies, as MBIA is doing with Fitch, the system may become even more skewed.

One way around that is to introduce rules that require equivalent disclosure.
When a company provides information to one rating agency, it has to give that to
all other regulated agencies too — probably via some sort of database, Mason
explained.

MBIA’s request that Fitch destroy information suggests the company is very keen
to stop the agency from rating it in future, Mason said.

“It’s expected that this information would remain confidential, but to ask that
it be destroyed is really going the extra mile to stop Fitch rating them on an
unsolicited basis,” Mason said.

“This betrays the bias that’s currently in the system,” he added. “MBIA is saying
that because you’re not financially tied to us anymore, we really don’t want you
rating us.”

Sean Egan, president of Egan-Jones Ratings, an agency that’s paid by investors
rather than issuers, goes further, arguing that any confidential information
given to ratings agencies should be disclosed to all investors.

MBIA doesn’t provide Egan-Jones with the information it requests “because we’re
bearish on them,” he noted.

MBIA spokesman Jim McCarthy said Egan-Jones has never asked the bond insurer for
any information.

Egan responded later on Monday that Egan-Jones has asked MBIA for information and
will incorporate any new data into its assessment of the bond insurer. The agency
encourages companies to disclose that information to the rest of the market too,
he said.

“No firm should have preferential access to information. It should be available
to everyone in the market,” Egan said. “There’s no reason why rating firms should
be treated differently than other market participants.”

“This whole controversy highlights the problems that exist with the industry
structure, whereby a company can silence a rating firm if that company doesn’t
like the rating that’s being generated,” Egan said.

MBIA CEO sees $200 million in losses coming

MBIA said Monday that it expects $200 million in mark-to-market losses from its
credit-derivative business and said Fitch’s insurer-financial-strength ratings,
or IFS, can cause “serious volatility” in how the Armonk, N.Y.-based company is
viewed in the equity markets.

Brown said it was an appropriate time to ask the credit-rating agency to no
longer provide its IFS ratings. He added that he had, “very little idea why
Fitch’s capital model produces the charges it does, and why it can change so
rapidly at any point in time when there is no obvious change in our circumstance
or in the credit market at large.”

Shares of bond insurers such as MBIA and Ambac Financial Group (ABK) have plunged
of late as investors question their ability to survive the credit crunch and
maintain their all-important AAA credit ratings. The companies wrote policies
insuring billions of dollars of collateralized debt obligations and other
mortgage-related debt that could go into default.

In order to rating a company properly, agencies need as much information as
possible. They get confidential information about companies, but agree not to
divulge that to the market.

However, some agencies get more information than others, Mason explained.

“One of the main constraints to this practice of unsolicited ratings is the lack
of information given to some agencies,” he said. “MBIA’s request that information
be destroyed by Fitch is an example of this.”

“The good news is that we are starting to write some business in the new issue
market,” Brown wrote in the shareholder letter, dated March 9.

The CEO, however, acknowledged MBIA has made missteps.

“Make no mistake about it, we wrote some business that in hindsight we wish we
hadn’t, and those decisions have certainly had an impact on the market’s
confidence in MBIA,” Brown wrote. He was addressing the wide spread on credit
default swap contracts written by MBIA, despite the recent AAA ratings
affirmations by Moody’s and S&P.
“Given our robust financial position at MBIA Inc., I would certainly argue that
the existing spread in the short term is illogical,” the CEO said.

Among other possibilities, Brown said the spread could be the result of MBIA
“being used as a ping-pong ball in a high stakes games by the big guys.” Hedge
funds and other traders have made money shorting shares of MBIA and other bond
insurers that have suffered as a result of the credit-market turmoil.

Brown pointed out the company doesn’t have any principal payments pending on its
debt until 2010. He said it’s “highly improbable” MBIA will default over the next
year.

MBIA’s shares are down nearly 50% since the beginning of the year, lost more than
5% to change hands at $11.36 Monday morning.

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