Q: & A: with Jack Byrne, Chairman, and Robert P. Cochran, President and Chief Executives Officer of Financial Security Assurance Inc.
In June 1993, U S West Inc. sent shock waves through the financial guaranty industry when the firm announced its intention to focus on its core telecommunications business and divest itself of its holdings in Financial Security Assurance Inc.
In October, FSA filed for an initial public offering of 12 million shares and announced details of a major corporate restructuring designed to segregate the insurer from its troubled commercial real estate holdings. Problems in the commercial real estate sector plagued FSA in recent years, diluting its earnings and hampering its ability to compete with other isurers. Resolution of the issue was portrayed as a major necessity if FSA was to have a successful IPO.
After an aborted attempt to price the IPO in December, U S West struck a deal with Fund American Enterprises Holdings Inc. for 2 million shares, or 7.6%, of FSA. As part of the arrangement, Jack Byrne, Fund American's chairman, president, and chief executive officer, would become chairman of FSA.
Byrne, who was instrumental in revitalizing Fireman's Fund and GEICO Corp., is no stranger to the bond insurance industry. He was a founding shareholder of Bond Investors Guaranty Insurance Co. and a founding director of MBIA Inc.
Byrne's commitment was widely hailed as a key component to the success of FSA's initial public offering, which fetched $20 per share on May 7.
Byrne and Robert P. Cochran, FSA's president and chief executive officer, recently sat down with staff reporters Steven Dickson and Aaron Task to discuss FSA's outlook.
Q: Perhaps the biggest question surrounding Financial Security Assurance Inc.'s ownership structure was the resolution of its troubled commercial real estate holdings. Jack, before coming on board, what did you do to satisfy yourself that this issue was behind the company?
Byrne: We hired a real estate firm, a major Big Six accounting firm to give us their views, and two prominent law firms to satisfy me that the reinsurance agreements were solid.
Of course, [FSA's] management did it all, then Moody's Investors Service and Standard & Poor's Corp. went through it and satisfied themselves, and the underwriters went through it, too. So I was about the fourth one through.
I also visited one of the prominent reinsurers who was our insurance partner on a couple of these cases, just to get their independent view.
None of the parties said exactly the same thing, but the bottom line is I am satisfied that about 13% of the gross exposure remains on our books and the other 87% is on somebody else's books.
There's been no new business written since 1990 an you have a finite number of transactions. for the remaining exposure on our books, we have set up a $35 million reserve that looks to m y eye to be perfectly adequate. so I am satisfied that that's a closed chapter.
Q: You did your stock offering when the other publicly held companies were at two-year lows. Why did you do your initial public offering now?
Cochran: A little less than a year ago, U S West announced its intention to redeploy its capital in the telecommunications business, and to that end we've been working to take FSA public.
The market deteriorated dramatically in December and the transaction was not completed, but U S West continued its commitment to achieve that result and in the interim we were fortunate to have Fund American and Jack Byrne develop a strong interest in FSA.
It was that interest, together with U S West's continued strategic focus to withdraw its ownership, that led us into what as you say was a very difficult market environment. Notwithstanding that, the transaction from our point of view and from U S West's point of view was significant success.
Byrne: It was a tough time. We suggested to U S West that this might not be the best time, and wouldn't they prefer to let us go to work here and do an offering six months from now or something?
But U S West's strategic interests are that they really want to focus their attention back on their own business and so it was really their decision to go ahead. Under all the circumstances, I think we were quite positively received.
Q: Now that you're publicly owned company, how do you get across to off in refunding volume, the earnings are still going to be strong?
Cochran: The way I would respond to that is to say this is a long-term business, and FSA and the other companies are building long-term value based on capital strength and triple-A ratings.
The volume in the market in a given quarter or even a given year is unpredictable and will vary over time, but the fundamental characteristics of the financial guaranty insurance industry remain quite positive, and the annuity-building nature of the business will result in a continued rise in growth in earnings per share as well as in capital strength.
Byrne: We've spent a lot of time on the capital strengths of FSA and I made it clear from my perspective that I was willing to be very patient in terms of getting all of that capital to work.
If the market did not grow in 1994 over 1993 and we had extra capital that was sitting sort of on the sidelines as dry powder, that form my perspective as the new chairman of the board, I would not be impatient to get that to work. It will get to work in its own natural time, but building capital strength is more important than building the revenues growth.
Q: FSA is a little different than the other guarantors in that it started out on the asset-backed side and moved into municipals. What's your vision for the company in terms of how the two sectors are going to work together?
Cochran: Well clearly, FSA's strategic focus is an equal emphasis on building our position in the municipal market and maintaining our leadership in the asset-backed market. Second, there is no doubt that over time the companies in the industry will look more and more alike.
The companies that started in the municipal market are looking to build their presence in the asset-backed market, and FSA having started and built its franchise in the asset-backed market is looking to build in the municipal market. It's good for the industry.
Q: What king of feedback did you get from equity and bond investors during the IPO as to the two sides of the company?
Cochran: I think equity investors see [asset-backed securities] as a market that has significant additional growth potential both domestically and internationally, and one where FSA having begun that business nine years ago has the preeminent skill base.
On the fixed-income side, when we started our municipal efforts three years ago, many of the major municipal investors were somewhat fearful of the asset-backed business. Over time we've seen that level of discomfort fading, in part because of our own efforts to meet directly with investors and educate them, and because the other companies that were three years ago pure municipal players are no longer pure municipal players, and the investors are gaining comfort [from that].
Q: Other companies are getting into new lines of business like cash management and guaranteed investment contracts. Is that something you think FSA will consider as well?
Cochran: There's a natural tendency in any growing successful business to try to find ways to utilize the skills that got you to where you are, to continue to build the value in the business.
What I've seen so far on the part of the other companies in the industry is a very responsible use of their skill base to expand their ability to create value. I expect that to continue. Over time we will look to ways to create more value out of [our] skill base, but we'll always stay close to home in the things that we know and understand.
Q: Given your experience with Bond Investors Guaranty Insurance and MBIA Inc., how do you view the industry's evolution?
Byrne: I am surprised and absolutely delighted at the evolution of the business.
I can remember us sitting around a table back in 1984 when the insured share of the municipal bond business was under 20%. I seem to remember it was 14% and we were debating whether it could get up to 25%. Of course the market was much smaller, like $100 billion. So we were then looking at, can we get it up to 25% of $100 billion, and now it's 40% of over $300 billion.
So it is amazingly bigger than we ever dreamed it would be, and the business has turned out to be, frankly, a better business even than we thought it would be.
Q: How do you view the growing percentage of public ownership in the industry?
Byrne: I view the public ownership of three of the top four competitors as a very positive thing. It seems to me it gives us lots more flexibility in terms of need for capital.
I think public ownership also brings a discipline to the business. There's all kinds of arguments here, but there is no question that public ownership brings a type of discipline that private ownership does not.
Cochran: Public ownership is a positive for the industry for a couple of reasons.
The first is we believe that the fundamental characteristics of this industry are very attractive for the major participants in the industry. We see an industry which currently has seven primary financial guarantors -- there hasn't been a new entrant to the industry in six or seven years and we think the barriers to entry are sufficiently high that it is highly unlikely that there will be any new entrants for the foreseeable future.
But even more importantly, the top four companies in the industry constitute 90% of the capital and 95% of the premiums that are being generated. We think essentially those top four companies, three of which are now public, will dominate both the domestic asset-backed and municipal markets as well as opportunities, as they develop, internationally.
Q: Fitch Investors Service recently said that AMBAC Indemnity Corp., Financial Guaranty Insurance Co., and MBIA are becoming so big that they're pulling away from the rest of the industry. With your stated goal being to make FSA a member of "the big four," how do you go about attacking that perception?
Cochran: First of all, there's no doubt that the statistics which they cite in terms of return on equity performance and size of capital base are essentially accurate. However, our view is that size is only one important factor.
Capital strength in the end is the most important factor. If you take away the adverse experience from the commercial real estate line of business, FSA has had very attractive return on equity and growth in earnings over the past five year. That's been obscured by both the losses sustained in the real estates area as well as the additional capital held in place to protect that sector.
FSA is the fourth largest, we're nearly three times the size of the next largest competitor. We have a leadership position in one market, a strong solid foundation in the municipal market, and we think we can compete very effectively from that position.
Also, FSA has the largest margin of safety of the top four companies.
Byrne: We can have an outstanding business even if we never move from fourth to third. I don't see it as a legitimate objective of ours to try to move from fourth to third and third to second and whatever.
If we can maintain the current market shares in these very attractive markets that are themselves growing -- and maybe the European and Pacific Rim will become a big contributor, and we'd like to think we're in a leading position here -- we can have a wonderful business just as the fourth major competitor.