MoneyGram Rescue Plan At Risk

A much-needed investment from private equity firms depends on the company selling its remaining portfolio of impaired asset-backed loans

The subprime meltdown has found another victim: MoneyGram International (MGI). The money transfer services provider's stock lost half its value Jan. 15 after the company disclosed a plan to recapitalize its balance sheet that depends on its ability to shed its risky loan portfolio.

While the company has been a relatively conservative play on money transfer services to consumers, its other business of transferring money between banks and other financial institutions has turned sour. MoneyGram now faces larger losses after reinvesting money it receives for bank transfers in risky investments such as subprime mortgages.

After the market close on Jan. 14, MoneyGram announced an additional net unrealized loss of $571 million on its investment portfolio since Sept. 30, bringing total net unrealized losses to $860 million. The Minneapolis-based company is in the process of shifting its portfolio away from asset-backed securities and into highly liquid assets such as government bonds. So far this month, it has sold $1.3 billion of securities, resulting in a realized loss of about $200 million, double the $100 million unrealized loss it recorded at the end of November.

To preserve its liquidity, MoneyGram said it’s in negotiations with a group led by buyout firm Thomas H. Lee Partners to get capital infusions of $750 million to $850 million in convertible preferred stock and $550 million to $750 million in debt from third-party lenders. With $350 million available under credit agreements, the company believes it has ample liquidity to meet its daily needs.

An investment by Thomas H. Lee Partners would be contingent on MoneyGram’s liquidation of a major portion of its investment portfolio, which would result in losses much larger than the $860 million loss reflected in its Nov. 30 valuation, the company said. The investors would initially be getting a 60% to 65% equity stake in MoneyGram, depending on the amount invested and the size of the losses on the sale of assets from its securities portfolio.

The shares plummeted 49.5% to close at $6.15 on Jan. 15, after tumbling to an all-time low of $5.66 earlier in the day. The stock had traded as high as $30.93 within the past year.

In response to the company’s recapitalization plan, Standard & Poor's Ratings Services lowered its long-term counterparty credit rating on MoneyGram to ‘BB’ from 'BBB' and said the rating will remain on CreditWatch Negative, where it was placed on Dec. 13, 2007. (Standard & Poor’s, like BusinessWeek, is a division of McGraw-Hill Companies (MHP).)

The portfolio losses are related to MoneyGram’s Payment Systems business, which processes money transfers for home sales and other transactions between banks, reinvesting the money at higher yields for the seven to 10 days required for the transfer and earning a profit on the spread between the yields. Some of those higher-risk securities it had been investing in have turned out to be radioactive due to the subprime meltdown, Anurag Rana, an analyst at KeyBanc Capital Markets, told in an interview.

Now, instead of investing the money in those high-risk securities, MoneyGram plans to move to safer assets. The realigned portfolio is expected to consist mainly of government, government agency and municipal bonds, but the lower yields would substantially reduce the company’s profit margin.

In the third quarter, the company’s investment yield was almost 6.5%, but with the switchover to government securities, it will come very close to the Fed funds rate, said Mark Sproule, an analyst at Thomas Weisel Partners in New York. That would virtually wipe out any spread from which it had been making a profit.

The company expects to partially offset the shrinking interest rate spread by no longer processing transfers for the larger banks and focusing instead on smaller, regional banks that pay a slightly higher commission, Sproule said. “I expect the majority of the profitability from the Payments business to disappear,” he said.

Meanwhile, some analysts wonder if MoneyGram’s losses in its portfolio could be even worse.

The total losses ($200 million) on the sale of securities between September and January would seem to imply additional write-downs of roughly $1.5 billion, Credit Suisse analyst Paul Bartolai said in a Jan. 15 note. But losses could be higher since the securities sold were probably the most liquid in the portfolio, said Bartolai, who has a market weight rating on the stock. (Credit Suisse does and seeks to do business with the companies it covers in its research reports.)

Sproule at Thomas Weisel said he believes MoneyGram will be able to get around 85 cents on the dollar for the commercial and prime residential loans and the corporate debt it sells, and between 20 and 30 cents on the dollar for the subprime and Alt-A loans and collateral; debt obligations it still has in its portfolio.

That’s not surprising, considering the last pricing in the market was E*Trade Financial’s (EFTC) sale of $3.0 billion in second lien, subprime, double-A rated loans for $800 million, or about 27 cents on the dollar, just after Thanksgiving, he said.

Overall, he believes the company will be able to contain its writedowns to about $1.5 billion, most of which will be taken in the fourth quarter, and that’s the reason it arranged for waivers through Jan. 31 on its debt covenants that required it maintain certain minimal income levels.

The waivers allow the company to breach those income thresholds temporarily until the end of January, when the contract with the investor group led by Thomas H. Lee is expected to become definitive, with the funding to materialize in early February, Sproule said.

The deal with private equity firms such as Thomas H. Lee could fall apart given there’s no assurance MoneyGram will be able to sell the rest of its investment portfolio at an acceptable price, given the collapse of the market for some of the securities in that portfolio, Rana wrote in a research note on Jan. 15.

If a bailout doesn’t come from the group led by Thomas H. Lee, it’s likely to come from another “white knight,” given that the disclosure of the portfolio exposure will give potential suitors a better idea of what they’d be getting, Calyon Securities said in a Jan. 15 note.

Euronet Worldwide (EEFT), which made an unsolicited bid in December to acquire MoneyGram in an all-stock deal initially valued at $20 per share, is presumably still interested in the company’s money transfer business. Other suitors willing to swallow potential losses on the portfolio in exchange for the scale of the money transfer business could also appear, analyst Craig Maurer wrote in Calyon’s note. He upgraded the stock to neutral from sell, saying the shares had reached his $6 price target.

Despite an optimistic view of the money transfer business, Standard & Poor’s Equity Research cut its 2007 earnings estimate by 32 cents to $1.20 per share and shaved its target price by $14 to $12, saying its ability to forecast future profits was poor.

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