By Aline van Duyn, Saskia Scholtes and Michael Mackenzie
Published: January 24 2008 22:08 | Last updated: January 24 2008 22:08
In spite of a welcome ray of hope in the form of regulatory efforts to push for a potential cash injection from banks, sentiment in the bond insurance industry was once again clouded on Thursday by a realisation that a solution might not be imminent.
Hopes that banks might cough up some cash to plug holes left in the balance sheets of bond insurers such as Ambac and MBIA, which miscalculated the risks associated with assets backed by subprime mortgages, pushed their shares up sharply on Wednesday.
On Thursday, however, the euphoria subsided somewhat, not least because there was still a lot of detail to be ironed out and it was far from clear how many banks would back such a scheme.
Ambac’s shares fell 6.8 per cent by midday in New York to $12.77 and MBIA’s shares fell 13.2 per cent to $14.42.
Eric Dinallo, the New York State Insurance Superintendent who held talks with banks on Wednesday and has urged them to come up with as much as $15bn of cash for the bond insurers, made it clear no plan was ready to be announced.
“Clearly it is important to resolve issues related to the bond insurers as soon as possible,” said Mr Dinallo in a statement on Thursday. “However, it must be understood that these are complicated issues involving a number of parties and any effective plan will take some time to finalise.”
As the behind-the-scenes discussions continued on Thursday, and as bond insurers also continued to talk to potential equity investors such as private equity firms, another bond insurer lost its coveted triple-A rating.
Security Capital Assurance ditched its plans to raise $2bn in fresh capital, leading Fitch Ratings to slash its triple-A credit rating to single-A. This is not likely to be the end of the story – Fitch warned it may cut the ratings further. SCA’s shares were down 26.7 per cent at $2.78.
“[This] reflects the significant uncertainty with respect to the company’s franchise, business model and strategic direction; uncertain capital markets; the company’s future capital strategy; ultimate loss levels in its insured portfolio; and the challenges in the [bond insurer] market overall,” Fitch said.
Fitch, which has taken a more negative stance on the ratings of bond insurers than rivals Moody’s Investors Service and Standard & Poor’s, was clearly not anticipating an imminent cash shot from banks. The downgrade of SCA follows a cut of Ambac’s rating to AA by Fitch last week.
The worry is that other rating agencies may follow suit, and that the widespread loss of triple-A credit ratings could lead to losses for banks and other financial institutions with exposure to some of the over $2,000bn of debt guaranteed by bond insurers or hedges in which they are counterparties.
A bail-out could reduce these concerns, which have been hanging over the entire equity market. News of the talks about a capital infusion led to a powerful rebound for US stocks on Wednesday after a five-day losing run and on Thursday helped power the biggest gains in European stocks for almost five years.
“It would remove a lot of counterparty concerns that are hurting the financials,” said Doug Peta, strategist at J&W Seligman.
Some analysts said it was too early to say whether such a plan to bail out the monolines was feasible.
“Scepticism about a bail-out lies along three lines: whether the banks can overcome competing interests, whether the banks can actually afford the $15bn, whether the $15bn is enough,” said TJ Marta, fixed income strategist at RBC Capital Markets. Some analysts speculated that the banks might be forced them to raise additional capital, such as from sovereign wealth funds, given the constraints on their capital.
The problems for bond insurers, of which MBIA and Ambac are the largest, stems from their move into structured finance. Historically, bond insurers have guaranteed payments on debt borrowed by municipalities in the US. By allowing lower-rated entities to essentially piggy-back on the insurers’ triple-A credit ratings, for a fee, municipalities were able to sell their bonds to investors who only wanted top ratings.
Structured finance, which includes guaranteeing payments on bonds backed by other debt, some of it in turn backed by assets such as mortgages, has turned out to be riskier than their traditional municipal business, with higher rates of default. The scale of losses associated with such collateralised debt obligations (CDOs) is still not clear, and estimates have continued to rise in recent weeks.
This has led to shortfalls in capital needed to preserve triple-A credit ratings, and a crisis in confidence which has made it made it hard for MBIA and Ambac to get new business.
In a back of the envelope calculation, Geraud Charpin, analyst at UBS, said that a downgrade from triple-A to double-A would lead to an extra $10bn of higher counterparty risk at banks. Mr Charpin based this on the assumption that the insurers guaranteed about $2,200bn of debt, of which probably around $1,000bn is non- municipal debt.
“Of course, the writedown would be heavier in case of a complete failure [which would void the guarantee and force a full mark-to-market pricing of the securities],” Mr Charpin said. “At this stage we are not sure who already made appropriate – preventive – writedowns and who did not. It is possible the overhang of additional writedowns in bank books was overestimated by the market.”
Working out answers to these questions is now key, but not easy. One of the problems is that the level of losses associated with mortgage-backed assets is not yet known. Many analysts are now factoring in worst-case scenarios in terms of losses – a few weeks ago many only ascribed a low chance of that being the case.
Nigel Myer, analyst at Dresdner, said investment banks might be prompted to back a bail-out if they believe losses could be worse than currently expected.
“If structured finance valuations can be maintained and that market kept open, the cost of injecting new capital may be less than the writedowns that would otherwise be incurred should a [bond insurer] fall below double-A, which we believe to be a critical threshold,” he said. “Could a sweetheart deal within the industry work – we think it could, but the odds are against it because the incentive for each player is to stay out while others take part.”
http://www.ft.com/cms/s/0/8c8e20d8-cabb-11dc-a960-000077b07658.html
On a related note...over at CalculatedRisk:
http://calculatedrisk.blogspot.com/2008/01/egan-jones-monolines-need-200-billion.html
Thursday, January 24, 2008
Egan Jones: Monolines Need $200 Billion in Capital
From The Times: Mortgage bond insurers 'need $200bn boost'
America's biggest mortgage bond insurers collectively need a $200 billion (£101 billion) capital injection if they are to maintain their key AAA credit ratings, a figure that dwarfs a plan by New York regulators to put together a capital infusion of up to $15 billion ... Sean Egan of Egan Jones Ratings Company, said.The next few weeks should be very interesting for the monoline insurers.
