Category / Monoline
In honour of Ambac, filing tomorrow (and with apologies to the Lucky Boys):
Don’t you even try to jettison now
This has gone, this has gone as far as I can allow
This ships been sinking with you at the helm
Straight to hell, straight to hell, take a bond straight to hell
Rather like Lost, the Monoline Death Watch has been going on so long that one can neither remember all the twists and turns, nor rouse much enthusiasm for the final denouement. Still, the news from Bloomberg that Wisconsin Insurance Commissioner Sean Dilweg
is taking over a portion of Ambac’s policies to protect municipal bondholders who count on the company’s guarantees. He halted payments on the $35 billion of mortgage bond policies and other contracts
The press release is here: comment from Rolfe Winkler (who seems to be a rather less hysterical and better informed Reuters blogger than Felix Salmon) is here.
Basically Dilweg is segregating the muni insurance business written by Ambac Assurance Corp from the bad stuff, primarily CDS on ABS. The CDS counterparties will get 25 cents on the dollar or so, plus a share in any eventual upside from there. This is an event of default for credit derivatives referencing Ambac.
Update. There is a provocative post on the legal implications of the segregated account approach Ambac has taken by Stephen Lubben at Credit Slips here. I’m not up to speed with the details here, but it certainly seems that the possibility of being forcibly novated into a position with less access to liquidity and much less capital might be troubling to a counterparty…
I always thought that of the monoline insurer’s two businesses, writing wraps on muni bonds was safe, while writing wraps on structured finance instruments was dodgy. It seems I was wrong about the first part. From Bloomberg:
Ambac Financial Group Inc., the second biggest bond insurer, faces as much as $1.2 billion in claims if a judge in Nevada allows Las Vegas Monorail Co., which runs a train connecting the city’s casinos, to reorganize in Chapter 11 bankruptcy… The City Council of Pennsylvania’s state capital shelved a plan to sell taxpayer-owned assets to meet payments on $288 million of debt used for an incinerator funded in part with bonds insured by a unit of Bermuda-based Assured Guaranty Ltd. Harrisburg is weighing a possible bankruptcy filing.
With state tax collections last year through September showing the biggest drop since at least 1963, as measured by the Nelson A. Rockefeller Institute of Government in Albany, New York, local governments are seeking concessions from creditors of public projects, including bond insurers.
Ooops.
Update. A correspondent of Felix Salmon’s points out that the total claims-paying resources at National Public Finance Guarantee, the muni arm of MBIA, are $5.5B. That’s about 1.1% of its insured bonds. Hmmm, seems a bit light to me…
MBIA, once one of the most important monoline insurers, is sueing Credit Suisse for pervasive and material misrepresentation of the risk that they insured on RMBS. From Bloomberg via FT alphaville:
A Credit Suisse Group AG unit was accused in a lawsuit by MBIA Insurance Corp. of making fraudulent misrepresentations about mortgage-backed securities… [in a] transaction that was sponsored, marketed and serviced by the Credit Suisse units…
“CS Securities fraudulently induced MBIA to participate in the transaction,” MBIA said in the complaint. MBIA said the bank claimed it had “used certain strict underwriting guidelines to select the loans sold into the transaction when in fact it did not.”
So far, so ordinary. Insurers takes risk, insurer takes hit, insurer claims it did not know what it was doing because the client did not tell them everything, insurer sues is a sadly common story. But this one gets better:
Since the transaction closed, the securitized loans have defaulted “at a remarkable rate,” MBIA said.
“Through Oct. 31, 2009, loans representing more than 51 percent of the original loan balance, or approximately $464 million, have defaulted and been charged-off, requiring MBIA to make over $296 million in claim payments,” MBIA said.
MBIA said that a review of the defects of the loans included in the transaction show they were “systematically originated with virtually no regard for the borrowers’ ability or willingness to repay their obligations.”
One might wonder why MBIA did not notice this before they agreed to take the risk. So (as FT alphaville puts it) in order for MBIA to succeed, it will have to convince a court that its much-vaunted underwriting and due diligence weren’t actually all that great. Mind you, given that MBIA have gone from being AAA-rated to BB-, that might not be too much of a surprise to some people.
Felix Salmon discusses some recent JPM research on MBIA:
in a note issued this morning they said that MBIA’s tangible book value is actually negative, to the tune of about -$40 per share.
OK, the full article has some caveats. But the mere fact that a reputable investment bank (if that is not an oxymoron) can suggest that MBIA is insolvent should raise some warning signs about the extended historical fiction that is insurance accounting.
(The fate of the monolines was sealed by the risk they wrote in 2005-2007, so day 1000 is if anything conservative – it takes insurers a long time to die thanks to their accounting and the pay as you go nature of the claims against them.)
In a move so predictable it hardly raises a yawn, Bank of America, Citigroup, JPMorgan and 15 other large financial institutions filed suit on Wednesday against MBIA, claiming the bond insurer reduced its ability to pay policyholders by splitting its business in two.
It is difficult to think of how a monoline could split without generating lawsuits. If x of capital and y of investments support z of risk, and you split z into to pieces, how do you divide x and y? There is not widely agreed answer, so someone is going to think that the credit quality of the piece they end up with a claim against is lower that it should be – and they will sue. Moreover since there are clearly diversification benefits between risks, even if the split is entirely fair, the capital needed for the two pieces is larger than that for the original whole.
The lesson? Agree collateral upfront, based on your marks.
Watching the monolines die is a bit like listening to Fidelio. Intellectually you know that it going to end, but there are times when it feels like it cannot happen fast enough. Now we seem to have moved past the Komm, Hoffnung of Act 1 – there is no hope – and the protagonists are in chains. Specifically Syncora (which used to be called SCA – the name swapping in monoline land is as bad as that in a Shakespearean comedy, and a lot less funny) has stopped paying claims. This is of course a default event for CDS written on it. The FT story is here.
MBIA Inc. was sued by Third Avenue Management LLC… over claims the insurer’s split of its bond-insurance businesses hurts debt holders.Three mutual funds managed by Third Avenue bought notes issued by MBIA Insurance Corp. in February 2008 based on assurances that the company was recapitalizing following losses in its structured finance insurance business…
MBIA, the largest bond insurer by outstanding guarantees, said in February it was transferring $5 billion in cash and its public finance business to another entity that has no obligation to the notes, Third Avenue said in its statement.
The slow slide continues. Following S&P and in response to MBIA’s restructuring plan, Moody’s downgraded MBIA to B- from BBB+ on Wednesday. The best bit is on Bloomberg:
Credit-default swaps tied to MBIA Insurance Corp. jumped 7 percentage points to 60.5 percent upfront, according to CMA DataVision in London. That’s in addition to 5 percent a year. It means it would cost $6.05 million initially and $500,000 a year to protect $10 million for five years.
Given more than half a chance of failing within five years, according to the CDS market, you would have thought it wasn’t worth printing stationary for the new company. Maybe they could just cross out MBIS and write in National Public Finance Guarantee Corporation by hand.
From Bloomberg:
XL Capital Ltd., the biggest Bermuda- based insurer by assets, is seeking a buyer after reporting investment losses larger than its market value, four people with knowledge of the matter said.
Big oops. I could be mean about actuaries. I could be mean about monoline-type business models. But for now I just want to raise a glass to a company that was mostly a sophisticated risk taker. Sadly `mostly’ and `not enormously hugely massively well-capitalised – more capital than you can shake a stick at’ can be a toxic mixture.
Accrued Interest picked up something that I had missed, namely the continuing long slow death of the monolines. In particular Moody’s downgraded the last of the AAAs, FSA and Assured Guaranty, on Friday. Read about it here. This is rather like that poignant moment when the last of bottle of 1970 Lafite is drunk – although the smiles are a little less broad.
Confirming the insurance industry habit of substituting claims adjustment for underwriting diligence, MBIA is suing Countrywide according to Housing Wire:
The breach-of-contract lawsuit, filed in New York State’s Supreme Court, suggested that Countrywide developed a “systematic pattern and practice of abandoning its own guidelines for loan origination,” in effort to inflate its market share during the mortgage-lending boom. MBIA accused Countrywide of knowingly negotiating riskier loans “no matter the cost to borrowers, investors or guarantors like MBIA.”…Overall, the case involves 10 residential mortgage-backed securitizations of more than $14B in mortgage loans.
This is going to be interesting. On the one hand, it seems obvious that mortgage quality did decline in the last years of the Greenspan boom. But can MBIA really prove that Countrywide abandoned its own loan underwriting standards – rather than simply changing them to adjust to `market conditions’ – and that that was a breach of contract of the financial guarantees? If it can, we are going to see a lot more wriggling from the wrappers, and the lesson from Hollywood Funding – that insurers can’t always be trusted to pay when you think they have written protection – will be driven home to a lot more people.
Some morning reading:
On the duty of auditors. A taxing matter addresses the inherent conflict of interest and suggests that it might be a good idea for auditors to be hired by the SEC rather than the company.
Ultimate loss projections are increased by Moody’s. MBIA and Ambac have not been in a train wreck for weeks and they are getting jealous of all the attention Fannie, Freddie, AIG, Lehman, Merrill and so on are getting. The FT has the details.
One aspect of a run on a broker/dealer. Dealbreaker points out how a B/D share price fall can push clients into moving money from non-seg’d to seg’d accounts. The result is akin to a run on a bank.
And finally, given that Cristiano Ronaldo is on a lot of people’s lists as `worst role model in sport’, please will the Treasury drop AIG’s sponsorship of Man U as a matter of urgency, or at very least demand that Ronaldo’s legs are pledged as long term collateral and lodged permanently in a vault at the New York FED?
Lawyers to your keyboards. Ambac is pushing ahead with the good insurer/bad insurer model. From Bloomberg:
Ambac rose as much as 15 percent in late trading as Wisconsin regulators, which have jurisdiction over the New York-based company, approved a plan to move $850M out of Ambac Assurance Corp. into the new business, according to a statement today. Ambac is seeking to obtain an AAA credit rating … for Connie Lee.
Apart from the obvious questions — who gets the capital, who gets the muni derivatives, and why anyone thinks structured finance counterparties might be remotely comfortable with all this — don’t we have a bad enough history with two syllable first name one syllable second name companies? I mean, Indy Mac, Fannie Mae, Freddie Mac, … Connie Lee — it is not encouraging, is it?
In what is either a strong buy signal for the market or a strong sell signal on the stock, MBIA has announcing that it was not changing its projection of losses on its mortgage-related exposures. The FT story is here. Yes, they had some bizarre FAS 159 gains (CNN is here and my take on the rules is here): yes, they resumed a share buy-back programme. But ignoring all that, if their actuarial loss estimates for RMBS have not changed, either that is a very useful datapoint on where realised default losses actually will be, or their actuaries are fools and it is time to short the stock again. It will be interesting to see which.
Update. John Dizard has pointed out the possible value in the monolines as a vulture play on the eventual losses on RMBS. I can see the idea, but I’d like to know more about the implied residual value of the monolines given the current equity price. Are they really cheap yet?
This was my favourite blog title of the day: And now young monoline… you will die. Accrued Interest makes some good points, and indeed it must be frustrating trying to run a monoline when one’s de facto regulator, the ratings agencies, keep changing the capital model. However:
Anyway, Bill Ackman might fancy being able to buy another small country, so it is about time for another wave of monoline downgrades.
Yet another story about the travails of the monolines – this time on guaranteed investment contracts – made me think about who is really to blame for the mess these companies are in. It’s the people who made their underwriting decisions: their actuaries. They decided that there was little risk in guaranteeing investment returns for extended periods. They decided writing hundreds of billions of dollars of financial guarantees on ABS was a good risk return tradeoff. For that matter their colleagues in the life companies decided that variable annuity life policies were a good idea. (These policies, like a GIC, guarantee a return on a risky investments so they act a lot like long dated written puts: needless to say, the actuaries did not price them that way. Now that the equity markets are tumbling you can expect to see some life companies getting into distress…)
So perhaps one lesson that shines out of this mess is do not let an actuary price or risk manage a financial contract without help from a professional. They are not certain to screw it up. But the evidence of the last few years suggests that there is a real risk that they might get it very wrong indeed.
Recent articles (see for instance here, here, here, and here) have spurred a concern that I confess should have occurred to me earlier. What can cause an event of default by a monoline, and what happens next.
The first issue concerns the effective recovery for ISDA claims against a monoline. Here the crux is the relationship between the holding company and the insurer. As I understand it, most monolines are structured with a listed holding company and a regulated insurance sub. Obviously insurance contracts, including financial guarantee policies (whether transformed into CDS or not), are written by the insurance company, and so the insurance company has most (but not all) of the group’s capital to support this risk.
Which group company writes CDS? My suspicion is that it has often been the holding company. If the regulator seizes the insurer, it is almost certainly (but check your docs) an event of default on the CDS. But in that case the regulator will almost certainly not permit CDS counterparties to be paid at the expense of claims paying ability for the insurance business – they won’t let the money out of the insurer. The holding company will be left with a whole lot of liabilities and essentially no assets beyond a worthless stake in an insurer the regulator has taken over.
This is of course also an issue if you have debt issued by the holding company, or if you have transacted CDS referencing that debt. As Linklaters pointed out a few months ago, credit events can include quite minor regulatory intervention. I suspect that after such an event recoveries might be very low even if the operating sub is still perfectly capable of paying insurance claims.
Update. FT alphaville has additional reporting on FSA, CIFG and FGIC here, following their earlier story on MBIA. What I can’t see in the material I have read so far is whether a breach of regulatory capital requirement of the insurance sub is likely to be credit event on (a) CDS written by the parent and/or (b) CDS referencing the parent.
… or perhaps not if you are a monoline. Especially a press officer at a monoline. There’s lot’s of steam to generate as this list of current press releases from Bloomberg admirably demonstrates. Oh yes. Long coal, short insurers.
S&P lowered Ambac and MBIA to AA today. They are under review from Moody’s. Fitch, only six months late rather than the year or so of the other two agencies, downgraded them in January. Bill Ackman made another big pot of money. And there’s a nice opportunity opening in zombie monoline runoff…
Statement 163 requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation.
Specifically, from the standard itself:
The recognition approach for a claim liability relating to a financial guarantee insurance contract requires that an insurance enterprise recognize a claim liability when the insurance enterprise expects, based on the present value of expected net cash outflows to be paid under the insurance contract discounted using a risk-free rate, that a claim loss will exceed the unearned premium revenue.
For the monolines, of course, that means a realistic assessment of eventual credit losses. Now that isn’t an easy thing to do, and there is still a lot of wriggle room in how that standard is applied, but at least sticking their heads in the sand is no longer a sanctioned accounting standard.
Bloomberg reports MBIA had a substantial first quarter loss yet the stock went up:
MBIA Inc., the ailing bond insurer, rose in New York Stock Exchange trading after saying it will pump $900 million into its insurance unit and reporting a first-quarter loss that was narrower than some analysts’ estimates.
(The $900M is a downstreaming of cash from the parent into the insurer. That money cannot now be dividended to shareholders unless regulators are comfortable with the capital adequacy of the insurer: the funds came from a $1.1B capital raising in February.)
MBIA, whose market value has slumped 87 percent in the past year, gained as much as 9.8 percent as the company reported a net loss of $2.4 billion and an operating loss of $3.01 a share.
It seems that anything less than a cataclysm is a cause for celebration with the monolines at the moment.
Update. Bloomberg now reports:
MBIA Inc. and Ambac Financial Group Inc. had “meaningfully” higher losses on home-equity loans and collateralized debt obligations than anticipated, raising concern about their Aaa status, Moody’s Investors Service said.The losses elevate “existing concerns about capitalization levels relative to the Aaa benchmark,” Moody’s said in a statement today.
So instead of being, say, $10B short of AAA they are now $12 1/2 ? Big deal. Sabre rattling won’t make up for the downgrade that should have come months ago.
Warren Buffett’s new monoline is doing well, partly through writing wraps on already wrapped paper. From the FT:
Berkshire Hathaway’s fledging bond insurer generated $400m in premiums during the first quarter, outstripping all the established, but troubled, operators in the so-called US monoline insurance market.Many of the 278 contracts the unit wrote were for clients who already held policies from other triple-A rated insurers, Berkshire’s Warren Buffett said at the annual shareholder meeting in Omaha on Saturday. “They’re paying us a [higher] fee to write insurance that will only be paid if the principal [insured party] and insurer didn’t pay,” Mr Buffett said. “It tells you something about the meaning of triple-A in the bond-insurance field.”
I guess if you need a real AAA BHAC is one of the few places you can go. The interesting question is why people want that degree of credit protection on muni risk given the low underlying default probability.
From Bloomberg:
The first-quarter net loss was $1.66 billion, or $11.69 a share, New York-based Ambac said today in a statement.
That is over 10% of their claims paying ability (as stated in the 2007 annual report) in one hit.
Ambac fell as much as 22 percent in early New York Stock Exchange trading as new business slumped 87 percent after states and municipalities shunned its insurance and the market for mortgage securities dried up.
Looking into the detail, we find two major components of the loss: $1.7B mark to market loss on written credit derivatives held at fair value (primarily CDOs of ABS), and a $1B increase in reserving for written financial guarantees on RMBS accounted for as insurance. What I would really like to know is the balance of Ambac’s subprime risk taken via CDS vs. that taken financial guarantees. In other words, how does Ambac’s fair value write-down compare with its reserves? If $100M of ‘average’ (whatever that means) exposure taken via CDS generated $20M of write-down, say, how much did Ambac increase its reserves for $100M of average exposure taken via writing financial guarantees?
If things keep on going down like this it is going to get very messy. Still, at least Bill Ackman had a good day.
Update. Meanwhile other market participants old (FSA) and new are queueing to eat Ambac and MBIA’s lunch. The FT reports:
Two companies are considering opening new bond insurance firms – a large US bank and a large private equity firm – according to New York’s insurance industry regulator.
Finally, Calculated Risk has a post on adverse selection in the monoline’s portfolio: see also slides 31 & 32 of Ambac’s Q1 presentation. I’m not sure what exactly if anything one can conclude from the information, but it is interesting.
I have held off for a couple of days on commenting on this document not least because it is large, dense, and worth reading carefully. There is an awful lot of information in the full text here — the executive summary is here. In this post I will comment on chapter 1: posts on subsequent chapters will follow later in the week.
My tuppence ha’penny:
Here’s my problem. Consider the Basel 1 risk weights:
| Asset Class | Risk Weight |
| Cash, Good quality sovereigns, Insured residential mortgages, short term commitments | 0% |
| Loans to banks and muni risk | 20% |
| Uninsured residential mortgages | 50% |
| Loans to banks and muni risk | 20% |
| All other loans | 100% |
If assets are above 15T and RWA are at 5T the average risk weight is roughly 35%. How can that be given the preponderance of corporate and retail risk in the system? Remember RWA also includes derivatives risk which is off balance sheet and not included as an asset, so this number makes even less sense. If anyone can explain how the average Basel 1 risk weight for the banking system comes out at less than 50%, I should be very grateful. Certainly if the data above is correct, the IMF’s conclusion makes a lot of sense:
Bank supervisors need to take more account of balance sheet leverage as they assess capital adequacy.
The pace of credit growth in a squeeze would be reduced to a little over 4 percent of the outstanding private sector debt stock in the United States.
I think that is wildly optimistic. Everything we are seeing from the retail and commercial mortgage markets, for instance, suggests that credit growth will be negative for the next half year at least.
In the United States, the experience of the financial guarantors argues for reforms to U.S. insurance regulation.
Responsibility currently resides with the states, which has impeded coordination of regulatory efforts across states and with federal bank and securities regulators where spillovers are now evident. A new strategy for regulation of the financial guarantor sector needs to be implemented, including a coherent approach to capital adequacy and new limits on financial guarantors’ activities.
Fitch Ratings cut MBIA Inc.’s insurance unit to AA from AAA, saying the bond insurer no longer has enough capital to warrant the top ranking.MBIA, the world’s largest financial guarantor, would need as much as $3.8 billion more in capital to deserve an AAA, New York-based Fitch said today in a report. The outlook is negative, Fitch said.
Fitch issued the new, lower rating even though Armonk, New York-based MBIA asked the ratings company last month to stop assessing its credit worthiness.
My guess would be that Moody’s and S&P won’t crack under this news despite the evident fillip to Fitch’s reputation. Which is a shame.
An easy winner, this. From the FT:
The Federal Home Loan Banking system, a government-sponsored network of US banks, is seeking to enter the so-called “monoline” insurance market to help local governments that have been hurt by the credit market storm.In particular, some banks in the network want to offer their top-notch credit ratings to municipal infrastructure projects – and thus fulfil the role traditionally taken by monoline insurance groups such as MBIA.
Why not have them wrap structured finance too? I mean, what could possibly go wrong with pseudo public sector entities backed by taxpayers getting into an area of finance they have never been involved with before?
The dark cloud of uncertainty over the credit ratings of bond insurers Ambac and MBIA is slowly lifting, and sentiment in the credit markets and stock markets is improving as a result.
Moody’s Investors Service and Standard and Poor’s this week reconfirmed the triple-A ratings for MBIA. Standard and Poor’s had also confirmed its top rating for Ambac, where discussions continue about a deal with banks to inject fresh funds and restructure its business.
That may well be true, but the share prices don’t reflect it. Courtesy of Bloomberg, the picture to the right illustrates the equity prices for MBIA and Ambac.
This is turning into a complicated and difficult to navigate mixture of politics and economics. On a mark-to-market basis the largest monolines are almost certainly not AAA — but they are not mark-to-market players. Their leverage is terrifying. But they have powerful friends, and it is increasingly being seen to be in the industry’s interests that they survive at least in run-off if not as fully fledged players. Muni insurance is getting tougher with some states opting out entirely and Buffett soaking up much of the other business.
What does AAA mean? Almost nothing it seems. Hot on the heals of the agencies’ failure to downgrade MBIA and Ambac there is a lovely interactive graph from Bloomberg showing the collateral support for the AAA bonds in the ABX: Bloomberg concludes only 6 of the 80 deserve the rating.
Barney Frank has noticed that the disconnection of ratings from default probability is an issue for municipalities, who have been given a rating far below their PD, then charged for insuring their debt on that basis. And he wants to see some changes. According to Bloomberg:
Barney Frank gave ratings companies a month to fix “ridiculous” standards that they apply to local government debt, as his House committee opened a hearing today on how the firms evaluate municipal bonds.“I am going to say to the rating agencies and to the insurers: they have about a month to fix this,” Frank, the Massachusetts Democrat who chairs the House Financial Services Committee, told reporters in Washington yesterday. “We’re going to tell them they have to straighten it out.”
I think I like this guy…
Let’s look at the prospects for the monolines then. Barney is going to ensure the good quality states and other munis are rated AAA. A lot of muni insurance business goes away because of that. Buffett will eat much of the rest. And the structured finance market has disappeared too. Hmmm, business model, what business model?
Will one and a half be enough? Ambac tumbled yesterday on news that instead of an expected bank-based recapitalisation in excess of $2B, the monoline would instead do a $1B rights issue and sell $500M of hybrid securities. This is really calling S&P and Moody’s bluff. If Ambac’s judgment is that that they do not have the bottle to downgrade it, only a billion of new equity feels like a reraise on the river after flat calling the turn.
Ambac has also decided not to split. Presumably given Dinallo has no authority to force them to, and the legal risk of good insurer/bad insurer is great, this at least counts as rational.
