MoneyGram in shreds

Anyone listening to MoneyGram International Incorporated's quarterly conference call with analysts in July would have no reason to believe that nearly $1 billion in write-downs were around the corner.

Chief Executive Philip Milne boasted of the company's "very robust" growth in its money-transfer business. Chief Financial Officer David Parrin assured analysts that its investment portfolio was stable, even though the company invested in securities tied to the U.S. subprime market -- the sort of securities that had already triggered huge losses at hedge funds.

"Should we be worried that there's going to be some potential permanent impairment to some of these assets you guys are investing in?" asked Credit Suisse analyst Paul Bartolai.

"I think our current view at this point in time is that it would be temporary," answered Parrin. "There's been a lot of noise going on in the marketplace. ... And we've just got to get that to settle down."

The "noise," as Parrin called it, never did settle down, for large investment banks or for MoneyGram. On Monday the St. Louis Park-based company, the country's second-largest money-transfer firm, marked down its investment portfolio, including assets backed by risky subprime mortgages, by $860 million. MoneyGram's stock plunged nearly 50 percent in a single day, erasing more than a half-billion dollars of shareholder value.

Before announcing the write-down, MoneyGram entered into talks to sell a majority stake to an investment group led by buyout firm Thomas H. Lee Partners in a deal valued at between $5.50 and $6 a share.

That was less than half the share price at the time and a steep discount from the $20-a-share offer the company had spurned just a month earlier from rival Euronet Worldwide.

The sudden reversal of fortune for MoneyGram appeared to catch nearly everyone by surprise -- shareholders, analysts and credit ratings agencies. Investment banks Credit Suisse and A.G. Edwards raised their stock ratings on the company in August, just two months before the company announced a $230 million loss on mortgage-related investments and the stock began its precipitous slide. Shares closed Friday at $4.29, down from $30 in July.

Risky investing

Yet there were warning signs that a financial bomb was ticking at MoneyGram. In its annual report filed last March, MoneyGram said 89 percent of its investment portfolio was in nongovernment-backed securities (though "subprime" was never mentioned). That set MoneyGram apart from its main rival, Western Union, which primarily invests in safer government bonds.

Even when the company disclosed the extent of its subprime holdings -- at a Wachovia investors' conference on Sept. 11 -- investment banks continued to recommend the stock and ratings agencies didn't budge. At that meeting, MoneyGram disclosed that it held $384 million in securities backed by subprime mortgages, as of June 30, 2007, and that its total exposure to residential mortgage-backed securities was $1.5 billion.

"Up until then, I don't think many investors realized they had subprime [mortgages] in their portfolio," said Robert Napoli, an equity analyst who covers the company for Piper Jaffray & Co. "It's been frustrating to get information that's been useful."

Mark Henneman, cochair of the Mairs & Power Growth Fund in St. Paul, which owns about 1 million shares of MoneyGram, noticed early last year that the company's investment yields continued to grow -- a sign that it was likely investing in riskier securities. At an analysts' meeting in March he asked for more information about its investment portfolio. The company emphasized its high credit ratings and its conservative "buy-and-hold" investment strategy, he said.

"I left feeling comfortable that they weren't hanging it out there," he said. Now he wishes he'd pushed the issue more. (He said that Mairs & Power started selling the stock early in 2007 because the firm thought it was overvalued, but not because of any perceived risks in the investment portfolio.)

Blaming credit agencies

So far, MoneyGram executives have laid much of the blame for its problems at the feet of the nation's credit rating agencies, which continued to give securities backed by subprime loans high ratings despite warning signs in the subprime mortgage sector. The fallout from the subprime collapse has led to more than $100 billion in write-downs at the nation's largest financial institutions.

"Unfortunately, the reality is that we, along with most of the world's leading banks and financial service firms, purchased securities that received the highest investment grade from the ratings agencies, and those ratings turned out to be unjustified," CEO Milne said in a prepared statement. He declined to be interviewed for this article.

Adding further salt to shareholders' wounds is the fact that MoneyGram's huge losses have come from its slow-growth check-and-money-order business. Each time someone deposits money for a money order or official check, there is a brief period (typically no more than 10 days) before the recipient cashes the check.

MoneyGram invested that money in mortgage-backed securities because they offered a higher return than government bonds. But given that most of MoneyGram's profits come from fees earned from money transfers, and not from official checks or money orders, the extra returns never justified the risk, Napoli said. "They took aggressive bets in a business that generated a lower-quality earnings stream."

MoneyGram's future remains unclear. It is in discussions with both Euronet and Thomas H. Lee Partners. But Wall Street, judging by the flagging stock, doesn't think any of the deals will happen at current offers.

Why did MoneyGram spurn Euronet's offer back in December? The company claims Euronet refused to sign a confidentiality agreement, and MoneyGram did not want to expose the inner workings of its business to a rival without that certainty.

However, some on Wall Street took that as a bullish signal. MoneyGram shares actually jumped $1.10, or 7.6 percent, on Dec. 21, after the company said that it told Kansas-based Euronet it wasn't for sale.

Yet Euronet's offer likely would have come down dramatically once it took a closer look at MoneyGram's balance sheet, Napoli said. In the end, Euronet's offer might have looked very similar to Thomas H. Lee's.

"I don't think the outcome would have been that different for shareholders," Napoli said.

Regardless of who ends up owning MoneyGram, its top executives stand to benefit handsomely.

Milne will receive a total package of $16.18 million, including cash bonuses and stock, if he is terminated after a change of control, according to the company's most recent proxy statement. William Putney, chief investment officer, would get $6.5 million. All told, MoneyGram's top five executives stand to make $37 million in compensation if the company changes hands and they are terminated.

Chris Serres • 612-673-4308