by Calculated Risk on 2/19/2008 03:42:00 PM

From Dow Jones: Bond Insurer Woes May Cause $7-$10 Bln Hit For Banks: Moody's

Downgrades of bond insurers could require banks and securities firms to increase reserves by between $7 billion and $10 billion, rating agency Moody's Investors Service estimated on Tuesday.

If trouble in the so-called monoline business gets even worse, banks may have to set aside $20 billion to $30 billion to boost reserves covering counterparty risks, the agency added.
...
About 20 banks and securities firms have roughly $120 billion worth of hedges with financial guarantors on CDOs that contain asset-backed securities, Moody's said on Tuesday.

"We are currently evaluating these individual exposures to assess how institutions can absorb the additional counterparty reserves that might be required if one or more financial guarantors were downgraded," the agency said in a statement.

The headline states the obvious, but this gives an idea of the size of the problem according to Moody's.

by Calculated Risk on 2/18/2008 10:20:00 PM

From the WSJ: Ambac Hopes Capital Infusion Will Save Rating

Ambac ... is discussing a plan to raise at least $2 billion ... The extra cash, to be raised by selling shares to existing investors at a discount, would likely be a prelude to a trickier and lengthier move: splitting itself into two businesses.

The article discusses at length several of the difficult issues related to splitting the business:

Splitting the business between its municipal-bond and its riskier structured-finance operations ... would be financially and legally messy. It would pit policyholders and shareholders against both each other and regulators, and rankle investors, some of whom have been wagering through the credit-derivatives market that bond insurers would fail and default on debt.

So many different parties, and so many different and divergent interests, makes unscrambling the egg very difficult.

by Calculated Risk on 2/18/2008 12:15:00 PM

From Bloomberg: Bond Insurer Split May Trigger Lawsuits, Analysts Say

``Despite the regulatory interest in separating the exposures, the essential fact remains that all policy holders, whether municipal or structured finance, entered into contracts backed by the entire entity,'' analysts led by Jeffrey Rosenberg in New York wrote in a note to investors dated Feb. 15. A breakup is ``likely to lead to significant legal challenges holding up the resolution of the monoline issues for years.''
...
``The fact that one group of policy holders' exposures has imperiled the policies of the other does not mean they should forfeit the value of their claims altogether,'' the Bank of America analysts said.

This split isn't being driven just by regulatory interest. It appears that the combined company is worth less than the sum of the parts. Splitting the company will allow the "good bank" to write more business, increasing the value. The goal is to share that increased value equitably among the stakeholders (a difficult task) and minimize the lawsuits.

by Calculated Risk on 2/17/2008 08:42:00 PM

From the WSJ: Ambac in Talks to Split Itself Up (hat tip risk capital, sam)

Ambac Financial Group Inc. is in discussions to effectively split itself up ... A halving of Ambac would create one unit that insures municipal debt and one that would cover rapidly diminishing securities tied to the mortgages in a structure that effectively creates a so-called "good bank" and "bad bank."
...
Ambac is one of two bond insurers considering an effective break-up. FGIC Corp. on Friday notified Mr. Dinallo's office, the New York State Insurance Department, that it is pursuing an effective break-up. ... FGIC's plan came as a surprise to a consortium of banks ... and litigation may be one outcome. Ambac's plan is much further along and an announcement could be made this week.

It will be interesting to see how they unscramble the egg. I suppose the counterparties to the "bad bank" will receive equity in the "good bank".

From a finance perspective, it makes sense to split the companies. There is lost value in the "good bank" right now because they can't write new business. Splitting the company captures that lost value, and the only question is how that value - once captured - is split among the various parties. So I'd expect a split to happen, and happen soon.

by Calculated Risk on 2/15/2008 08:34:00 PM

From the WSJ: Bond Insurer Seeks to Split Itself, Roiling Some Banks

The beginning of a messy endgame to the bond-insurance crisis may be under way, and the industry that emerges could look very different from the one that bet big on subprime mortgages.

On Friday, Financial Guaranty Insurance Co., the nation's third-largest bond insurer, told the New York State Insurance Department that it will ask to be split into two separate companies. The idea would be for the new company to insure safe municipal bonds and for the existing one to keep responsibility for riskier debt securities already insured, such as those tied to the housing market.

The move may help regulators protect investors who have municipal bonds insured by the firm. But it could also force banks who are large holders of the other securities to take significant losses.
...
All of the banks have hired legal counsel and are prepared to go to court. The person familiar with the situation said FGIC's move could result in "instant litigation."
...
One plan the parties are discussing involves commuting, or effectively tearing up, the insurance contracts the banks entered into with FGIC ... In exchange, FGIC would pay the banks some amount to offset the drop in value of those securities, or give them equity stakes in the new municipal-bond insurance company.
...
"You're trying to unscramble the egg," said William Schwitter, chairman of the leveraged-finance practice at law firm Paul Hastings. "When you take a balance sheet that is supporting a variety of obligations and try to split it in two, it's difficult."
...
However, if a breakup is endorsed by the New York Department of insurance, that could limit the legal liability.

This really is unscrambling the egg. If the company is split in two, the muni bond insurer will probably be fine, and there is a strong possibility that the risky insurer would file bankruptcy. This would never work without some sort of agreement to limit the liability of the muni bond insurer. If the goal is to get the muni market functioning again - as it appears is the main goal of the NY Dept. of Insurance - then this makes sense. In that case, the banks will be revisiting the confessional soon.

by Calculated Risk on 2/15/2008 10:03:00 AM

From the WSJ: FGIC Will Request Break-Up

Financial Guaranty Insurance Co., a major bond insurer, has notified the New York State Insurance Department that it will request to be split into two companies.

One of the firms would likely retain much of the business of insuring structured finance bonds such as those backed by mortgages, which have come under severe pressure due to the housing market slowdown, according to a person familiar with the matter.

The other company would likely retain most of the municipal bond insurance business, which is stronger....

by Calculated Risk on 2/14/2008 05:57:00 PM

Patrick M. Parkinson, Deputy Director, Division of Research and Statistics testified today to Congress on Bond Insurance. Here are a few excerpts:

... downgrades [of bond insurers] might adversely affect financial stability through several channels. These include: (1) the potential for disruptions to municipal bond markets, (2) potential losses and liquidity pressures on banks and securities firms that have exposures to the guarantors, and (3) the potential for further erosion of investor confidence in financial markets generally.

Parkinson provides a discussion of what is happening in the muni bond market:

If guarantors are downgraded to below AA-, many money funds will be required to put tender option bonds and variable demand obligations back to the liquidity providers. Investors may also choose to put securities back in advance of potential downgrades. Indeed, some money market funds reportedly have already exercised this option with respect to securities insured by those guarantors with significant exposure to CDOs of subprime RMBS.

And on the banks:

Of greater concern is the potential for losses at banks that have hedged their holdings of super senior tranches of CDOs of ABS with credit protection purchased from the guarantors. These hedges lose value when the financial condition of the guarantors deteriorates. In fact, many banks already have written down the value of their hedges significantly to reflect the market view that some guarantors may not meet their obligations on the protection they sold to the banks. Thus, further downgrades of the guarantors may not necessarily require those banks to write down the value of their hedges significantly further. However, as long as the concerns about the ability of some guarantors to meet their obligations persist, any further declines in the value of the banks' holdings of CDOs of ABS will not be fully offset by increases in the value of their hedges.

Even if banks' losses from exposures to the guarantors are moderate relative to capital, banks could experience significant balance sheet and liquidity pressures if they take significant volumes of tender option bonds, variable-rate demand obligations, or ARS onto their balance sheets. The banks that have these exposures are currently well capitalized. However, if these banks take on significant-enough volumes of such securities, the resulting downward pressure on capital ratios might prompt some of them to raise additional capital or constrain somewhat the growth of their balance sheets to ensure that they remain well capitalized. Efforts to constrain the growth of their balance sheets could be reflected in somewhat tighter credit standards and terms for a variety of bank borrowers, including households and businesses. Many banks already have tightened lending standards and terms, likely in part because of balance sheet pressures associated with recent turmoil in financial markets. Further tightening would add to the financial headwinds that the economy already is encountering.

Part of the problem is no one knows how large the losses will be. As Parkinson notes, even moderate losses for the banks can result in further tightening and exacerbate the credit crunch.

by Calculated Risk on 2/14/2008 03:15:00 PM

From Bloomberg: FGIC Insurance Credit Ratings Cut to A3 From Aaa By Moody's (hat tip John)

FGIC Corp.'s bond insurance units had their credit ratings cut six levels to A3 from Aaa by Moody's Investors Service.

``These rating actions reflect Moody's assessment of FGIC's meaningfully weakened capitalization and business profile resulting, in part, from its exposures to the U.S. residential mortgage market,'' Moody's said in a statement today.

by Calculated Risk on 2/14/2008 03:02:00 PM

From MarketWatch: Bond insurers have days to re-capitalize, Spitzer says

Bond insurers have four to five business days to re-capitalize themselves enough to keep their crucial AAA credit ratings, New York Governor Eliot Spitzer said during a Congressional hearing ... If that doesn't happen, regulators will have to step in and separate bond insurers' municipal businesses from their more troubled structured finance units.

The next few days should be interesting.

by Tanta on 2/12/2008 09:32:00 AM

Buffett offers to separate the sheep from the goats. The goats are not happy:

Feb. 12 (Bloomberg) -- Billionaire investor Warren Buffett said he offered to assume responsibility for $800 billion of municipal bonds guaranteed by MBIA Inc., Ambac Financial Group Inc. and FGIC Corp.

Buffett's Berkshire Hathaway Inc. would put up $5 billion as part of the plan that would exclude subprime-related obligations. One company has already rebuffed the proposal and the two others haven't responded, Buffett told CNBC television.

Buffett is attempting to take advantage of the distress among bond insurers by picking off the profitable municipal guaranty business and leaving MBIA, Ambac and FGIC with debt that has caused more than $5 billion in losses. The three companies are struggling to maintain their AAA ratings after writedowns on the value of mortgage guarantees.

``If you gave up your entire municipal business, that's the book of business where the value in the companies is right now,'' said CreditSights Inc. analyst Robert Haines. ``You'd essentially be ceding that whole book to Buffett and what you'd be left with would be the book of business where all the troubles are.'' . . . .

If the municipal debt was reinsured by AAA rated Omaha, Nebraska-based Berkshire, the municipalities would also retain the top rating, Buffett said.

``The insurance in the market is not doing bondholders any good and is in some cases penalizing bond investors,'' Buffett said. ``Our proposal puts the municipals at the front of the line.''

The downgrade of a large bond insurer would force some insurers to sell any municipal debt that didn't have an underlying AAA rating.

``It would solve it in one stroke of a pen,'' Buffett said of the plan.

*Everything But Subprime

by Calculated Risk on 2/08/2008 04:19:00 PM

A few weeks ago, I mentioned Sean Egans (of Egan-Jones) estimate that the monoline insurers need $200 billion in capital.

To balance Egans' view, here is a response from Thomas Brown at Bankstock.com: Sean Egan: Giving the Backs of Envelopes a Bad Name

I got a call last week from Sean Egan of bond rater Egan Jones after I expressed doubt here about his much-bandied-about estimate ...

... Egan told me that he looked at each guarantor’s subprime mortgage and second lien exposure, and simply assumed 30% loss across the board. He then added up his estimates for all the guarantors, and arrived at $80 billion. Then he multiplied that by three, on the assumption that the rating agencies require three times anticipated losses to maintain a AAA rating. Then he took the result, $240 billion, and rounded it down to “over $200 billion” because it was such a big number.

I kid you not. Sean Egan has done the impossible. He’s managed to make S&P and Moody’s look like models of analytical rigor by comparison.

If accurate, I'm very surprised Egans' analysis wasn't more rigorous.

Here is another bearish view from David Roche writing in the Financial Times: Insight: The fire threatens credit insurance

If the monoline guarantees on bonds and credit derivatives were to be removed, the rule of thumb is that every 1 per cent decline in the price of insured bonds would give rise to $10bn of losses on bond portfolios elsewhere in the system. We estimate bond portfolio losses of $150bn-200bn were this to happen – or equivalent to the impact of the subprime crisis on the US banks.

I'm not confident that anyone has a concrete estimate of the future losses. Part of the problem is the insurers only pay for actual realized losses, and it takes a long time for those losses to show up (even though we all know they are coming). This is a story that will unfold slowly, and the ultimate losses depend on how far house prices fall, and on how many homeowners default.

by Calculated Risk on 2/08/2008 12:22:00 PM

PR from Fitch: Fitch Places 87 RMBS Bonds Wrapped by MBIA on Rating Watch Negative

Fitch Ratings has placed 87 classes of residential mortgage-backed securities (RMBS) guaranteed by MBIA on Rating Watch Negative. Fitch placed MBIA's 'AAA' Insurer Financial Strength (IFS) on Rating Watch Negative following Fitch's announcement that it will be updating certain modeling assumptions in its ongoing analysis of the financial guaranty industry.

With the possibility that modeled losses for structured finance collateralized debt obligations (SF CDOs) may increase materially as a result of these updated projections, Fitch believes that loss projections will be most sensitive to loss given default assumptions used for SF CDOs that reference subprime RMBS collateral. Fitch will update the market upon conclusion of its analysis.

The ratings agencies are still tiptoeing towards the eventual downgrade.

by Calculated Risk on 2/08/2008 12:12:00 AM

From the WSJ: MBIA Share Offering Boosted to $1 Billion

Bond-insurer MBIA Inc. said it boosted the size of a share offering to $1 billion from $750 million after it was oversubscribed by investors.

The Armonk, N.Y.-based company said it priced 82,304,527 shares of common stock at $12.15 a share to raise $1 billion.

MBI closed at $14.20 yesterday, so this offering is priced $2 under the current price.

by Calculated Risk on 2/07/2008 04:44:00 PM

From Bloomberg: Security Capital's Bond Insurer Loses Aaa at Moody's (hat tip jg)

Security Capital Assurance Ltd.'s bond insurance units, hobbled by a decline in subprime mortgage securities, lost their Aaa credit rating at Moody's Investors Service.

XL Capital Assurance Inc. and XL Financial Assurance Ltd. were cut six levels to A3, New York-based Moody's said today in a statement. The outlook for both is negative, Moody's said.

SCA, based in Hamilton, Bermuda, was stripped of its top ranking at Fitch Ratings last month ...

Also see Deutsche Bank AG Chief Executive Officer Josef Ackermann Says Bond Insurers Threaten Debt `Tsunami' comments today:

Deutsche Bank AG Chief Executive Officer Josef Ackermann said rating downgrades for bond insurers pose risks that could match the U.S. subprime market collapse.

``It could be a tsunami-like event comparable to subprime,'' Ackermann said in a Bloomberg Television interview in Frankfurt today.

by Calculated Risk on 2/06/2008 11:27:00 PM

From Bloomberg: MBIA to Raise Additional $750 Million of Capital

MBIA ... plans to raise an additional $750 million by selling about 50.3 million common shares, bolstering capital in an attempt to retain its AAA credit rating.
...
``The most significant fact is that they're raising the amount of capital from what they previously announced,'' Wilbur Ross, an investor in distressed companies, said in an interview with Bloomberg TV. ``I would be astonished if they hadn't consulted with the rating agencies before they made this announcement,' he said, adding that MBIA may retain its AAA.

And from the WSJ: Rescue Plans Won't Prevent Downgrades

... some banks and investors working toward salvaging the bond insurers ... are realizing that even the best plans could require them to settle for less -- less risk, less reward and bond insurers with less-than-triple-A ratings in the future ...

The banks are trying to figure out how to commute, or unwind, their credit-default swaps, which are contracts they entered into with ... bond insurers to guarantee their portfolios of complex debt securities known as collateralized-debt obligations, or CDOs ... In exchange for unwinding the contracts, FGIC and Ambac could give the banks stakes in their companies through warrants ...

The banks, then, would share in the proceeds that the bond insurers would make as they collect premiums and wait for their existing portfolio of policies to expire, or "run off." In this scenario, the most the banks are hoping for is that the bond insurers' credit ratings don't fall below double-A ...

If some of the recent loss estimates are even remotely correct, these are just delaying tactics.

by Calculated Risk on 2/05/2008 06:55:00 PM

From Fitch: Fitch Takes Rating Actions on 172,326 MBIA-Insured Issues

Concurrent with its rating action earlier today on MBIA Insurance Corp. and its affiliates (MBIA), Fitch Ratings has taken various rating actions on 172,326 bond issues (172,168 municipal, 158 non-municipal) insured by MBIA. ...

Fitch placed MBIA's 'AAA' Insurer Financial Strength (IFS) on Rating Watch Negative following Fitch's announcement that it will be updating certain modeling assumptions in its ongoing analysis of the financial guaranty industry.

Quite a few ripples in the pond.

by Calculated Risk on 2/05/2008 04:04:00 PM

From Fitch:

Fitch Ratings announced today that in light of consensus movement towards a view of increased loss projections for U.S. subprime residential mortgage backed securities (RMBS) that is now held by various market participants and observers, including Fitch, that the agency will be updating certain modeling assumptions in its ongoing analysis of the financial guaranty industry. Fitch believes it is possible that modeled losses for structured finance collateralized debt obligations (SF CDOs) could increase materially as a result of these updated projections. The need to update loss assumptions at this time reflects the highly dynamic nature of the real estate markets in the U.S., and the speed with which adverse information on underlying mortgage performance is becoming available.

Fitch believes that a sharp increase in expected losses would be especially problematic for the ratings of financial guarantors -- even more problematic than the previously discussed increases in 'AAA' capital guidelines, which has been the primary focus of recent analysis of the industry. Expected losses reflect an estimate of future claims that Fitch believes would ultimately need to be paid by a guarantor. A material increase in claim payments would be inconsistent with 'AAA' ratings standards for financial guarantors, and could potentially call into question the appropriateness of 'AAA' ratings for those affected companies, regardless of their ultimate capital levels.

Fitch expects in addition to increases in expected losses, that its capital guidelines are likely to increase materially as well.

An increase in both expected losses and capital guidelines would place further downward pressure on the ratings of those five financial guarantors - Ambac Assurance Corp. (Ambac), CIFG Guaranty (CIFG), Financial Guaranty Insurance Co. (FGIC), MBIA Insurance Corp. (MBIA) and Security Capital Assurance Ltd. (SCA), the parent company of XL Capital Assurance Inc. - that Fitch has previously identified as having material subprime exposure within their insured portfolios. Ratings on three of these guarantors - Ambac, FGIC and SCA - were recently downgraded by Fitch, and their ratings remain on Rating Watch Negative. In separate releases in conjunction with this announcement, Fitch has also placed the 'AAA' insurer financial strength ratings of CIFG and MBIA on Rating Watch Negative.
emphasis added

This bears repeating: The new modeled losses could "call into question the appropriateness of 'AAA' ratings for those affected companies, regardless of their ultimate capital levels." Regardless of capital levels. That really says it all.

by Calculated Risk on 2/04/2008 12:54:00 AM

Quote of the day from the Financial Times: Private equity firms unlikely to rescue Ambac and MBIA

"If we worry that we can get shot from the shadows by something we can't see coming, it is not for us," says the managing director in charge of financial service investments for one of the leading private equity funds.

"The financial guarantors pass neither the shadow test nor the ability-to-understand test."

The downgrade watch continues.

by Calculated Risk on 1/31/2008 04:14:00 PM

From S&P (no link):

Standard & Poor's Ratings Services today lowered its financial strength, financial enhancement, and issuer credit ratings on Financial Guaranty Insurance Co. to 'AA' from 'AAA' and its senior unsecured and issuer credit ratings on FGIC Corp. to 'A' from 'AA.' Standard & Poor's also placed all the above ratings on CreditWatch with developing implications.

At the same time, Standard & Poor's placed various ratings on MBIA Insurance Corp., XL Capital Assurance Inc., XL Financial Assurance Ltd., and their related entities on CreditWatch with negative implications. The ratings on various related contingent capital facilities were also affected.

Update: And from the WSJ a long time ago (this morning): AAA Rating Will Stand, MBIA Says.

Chief Executive Officer Gary Dunton mounted a spirited defense on a conference call, following MBIA's quarterly earnings report, against "fear mongering" and "distortions' that he said have contributed to last year's dramatic stock-price decline. He also said that MBIA's capital plan currently exceeds all stated rating agency requirements.

MBIA hasn't been downgraded so far; this is just a move to CreditWatch with negative implications. BTW, I don't think a CEO should ever comment on his company's stock price, only on the performance of the company:

Despite the significant losses posted by the company, Mr. Dunton said, "there is nothing that we can identify that justifies the 80% drop in our stock price since last year."

by Calculated Risk on 1/31/2008 01:16:00 AM

From Bloomberg: MBIA Posts Biggest Loss; Considers New Capital Plans

MBIA Inc., the world's largest bond insurer, posted its biggest-ever quarterly loss and said it is considering new ways to raise capital ...

The fourth-quarter net loss was $2.3 billion ... raising concern the ... company will lose its Aaa rating at Moody's ... Without the Aaa stamp, MBIA would be unable to lend a top rating to new securities, crippling its business and throwing ratings on $652 billion of debt into doubt. ... Bond insurers guarantee $2.4 trillion of debt combined and are sitting on losses of as much as $41 billion, according to JPMorgan Chase & Co. analysts. Their downgrades could force banks to write down $70 billion, Oppenheimer & Co. analyst Meredith Whitney said yesterday in a report.

The ratings watch continues.