MBIA turning the tables

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NEW YORK (Fortune) -- After years of being dogged by questions about the strength of its balance sheet, MBIA is turning the tables.

MBIA (MBI) grabbed headlines this past weekend by asking Fitch, the No. 3 rating agency, to withdraw its financial strength ratings on MBIA's insurance unit. MBIA pointed to Fitch's "limited" coverage of the credits MBIA underwrites and the prospect of investor "misinterpretation" of the resulting ratings.

But a letter MBIA chief Jay Brown sent Friday to Fitch takes the criticism a step further. In the letter, released Friday afternoon by Fitch, MBIA contends that Fitch is letting municipal bond insurers skate by on inadequate capital. The company says this supposed shortcoming could hurt MBIA as it moves toward a split of its muni bond and structured finance businesses.

"As we evaluate the capital structure for a stand-alone public finance business entity, Fitch's capital allocation is approximately half that of the other rating agency capital models," Brown wrote Friday to Fitch managing director Keith Buckley. "We believe this level of capitalization at the triple-A level is inappropriate and would pose a serious financial threat to our insured policyholders."

There's a bit of irony in that statement. For most of this decade, critics such as short-seller Bill Ackman have been saying MBIA is the one that's undercapitalized. They have questioned the underwriting standards that led MBIA to insure billions of dollars worth of collateralized debt obligations and other risky structures that are losing value in the market as the housing bust deepens.

Even now, after MBIA and rival Ambac (ABK) raised a total of $4 billion in new capital, many foes of the so-called monolines question the rating agencies' rationale in maintaining the firms' triple-A claims-paying ratings. By MBIA's own reckoning, trading in its credit default swaps gives the company 60% odds of defaulting on its obligations at some point in the next five years - not exactly the sign of a fortress balance sheet.

So some observers reacted with skepticism Monday when MBIA pointed its finger at Fitch. That's "a bit of the kettle calling the pot black," says Sean Egan of independent rating agency Egan-Jones of Haverford, Pa.

Egan-Jones has been bearish on MBIA stock since last June, Egan says, when the stock traded above $60 a share - compared with a recent $11. The firm also has been critical of Fitch, Moody's, and S&P for what he calls their conflicts of interest in being paid by bond issuers, rather than investors, as Egan-Jones is.

Egan says MBIA's problem is that over time, claims on CDOs and so-called CDOs squared are likely to dwarf the company's capital base. A recent presentation by an MBIA competitor, Assured Guaranty (AGO), says MBIA has $22 billion of CDO and CDO-squared exposure from 2005-2007, which are the years in which defaults and delinquencies have risen substantially above previous norms, against just $15 billion worth of claims-paying resources.

"The core problem has been and remains one of misassessment of risk, and mispricing of risk," Egan says. Investors "need to have a higher level of comfort" with the company's obligations down the road, he adds.

Despite a recent flurry of letters to shareholders, MBIA's Brown has been fairly close-mouthed on that issue. His only comment in Monday's letter on that score was that MBIA has $28 billion in assets backing $28 billion of insurance liabilities.

Still, the new CEO has certainly succeeded in shaking up MBIA since he arrived last month to replace his predecessor, Gary Dunton. In just the past few weeks he has announced the layoff of 48 workers, launched a bid to change the taxation of insurance companies with offshore affiliates and suspended MBIA's structured finance business.

MBIA's move may be understandable from a business perspective, given the muni bond insurance landscape. The company has seen a sharp drop in underwriting business since its ratings started getting reviewed at the end of last year, as municipalities such as California issue bonds without insurance and better-positioned rivals such as Assured Guaranty and FSA - which haven't insured tens of billions of dollars in CDOs - take market share.

Brown warns in Friday's letter that Fitch's standards could allow competitors to join the municipal bond guaranty business without holding sufficient capital. "Using Fitch's methodology, we believe these companies will not maintain a level of capitalization consistent with the triple-A standards that have been long-standing for this industry," he wrote, "and they will not assist the industry in bringing stability back to this important constituency."

But there is more irony here, even beyond the questions about MBIA's own standards. The most widely noted entrant to the muni bond insurance industry this year has been Warren Buffett's Berkshire Hathaway Assurance. Unlike MBIA or Ambac, Buffett's Berkshire Hathaway (BRKA, Fortune 500) conglomerate boasts a triple-A rating that isn't in any danger of being reviewed.

Fitch said Friday that it is "disappointed and surprised" by MBIA's request to withdraw the ratings. A Fitch spokesman didn't immediately return a call Monday seeking comment.

Regardless of who the competitors are, Brown holds out hope in Monday's letter to shareholders. "The good news is that we are starting to write some business in the new issue market," Brown writes, "and I have my first couple of credit underwriting meetings this week." Meetings, such as they are, are "a lot more fun than writing letters."