Monday, June 23, 2008

Good Lord More Bad Craziness From The Monolines

There's a tricky balance going on right now in the monoline bond insurance business. How do you stay in front of the short sellers (or credit default swap buyers, whose opinion of your business prospects is the same as the shorts) without taking moves that will spook the markets? And if you decide to throw money at your reputation, not unlike some opaquely-run state oil company taking space in a "sponsored supplement", only with 50,000 times more money and no advertising commission for 23-year-old graduate trainees, how much is enough?

We had a couple of capital raisings from the big two, MBIA and Ambac, earlier this year. These stock sales, which brought in slightly less than the two hoped, ultimately weren't enough to save their triple-A ratings. FGIC and XL didn't bother, and both are now deeply downgraded. CIFG announced, with great fanfare, an impressively large infusion from its French parents. Wasn't enough.

The two monolines in the best health, Assured Guaranty and FSA, also announced capital raisings, but stressed that this was to pursue business opportunities created by the implosion of the other four. And that worked rather well. Most new municipal and infrastructure finance business has been written by FSA and Assured, with Berkshire Hathaway snapping up a little bit of new business, too.

[Slight digression here. It's weird to observe the talismanic power of Warren Buffett at work in the bond insurance sphere. Without any evidence in support, one comment I read recently announced that with a $400 million raft of business, Buffett had "taken over the industry" (I can't find it, unfortunately). That picture is, um, some way from reality, the hopes of state treasurers notwithstanding]

So, for a while now we had this neat little ordering, with FSA and Assured on top, Berkshire Hathaway as the sprightly new entrant, and MBIA and Ambac sick and old. And then Bill Ackman, scourge of the big two, started buying credit default protection on FSA. Accrued Interest, the blog to which I've linked, wondered what bit of FSA's business he was worried about. We certainly don't get any enlightenment from the Deal Journal piece, a not massively curious greatest hits space-filler.

The post's writer, Heidi Moore, even offers up this little gem, a masterpiece of empty prognostication:

Although Buffett and Ackman haven’t spoken–or so we hear–the comment affirms their mutual economic self-interest in the death of the bond-insurance industry as we know it now.

No Heidi, Buffett and Ackman share the goal of seeing all non-Berkshire Hathaway bond insurers go bankrupt. Moore doesn't bother to say which bits of "as we know it now" will live and die. Maybe she refers to the structured finance bits of their business, or the CDS bit, or the collateralised loan obligations bit, or the bits of the business that might die because of the agencies' mapping municipal ratings to the global scale. I've no idea, and suspect that she doesn't either. Let's just say that Ackman's tongue baths from reporters are getting very Buffett-esque these days.

Still, even a stopped clock, and all that, because something in Ackman's presentation certainly rattled FSA and its owner, Franco-Belgian public finance bank Dexia. From an awesomely tedious and gratuitously colorless press release that FSA put out this morning:

Financial Security Assurance Inc. (FSA), announced today that Dexia will provide a $5 billion committed, unsecured standby line of credit to the Company’s Financial Products (FP) segment, which issues guaranteed investment contracts to municipal issuers and others requiring Triple-A rated deposits. The line will have an initial term of five years and will be renewed as needed thereafter.

To give you an idea of the scale of this backstop, MBIA says it has $16 billion in claims-paying resources, and FSA has just tapped its Franco-Belgian parent for almost a third of this total to prop up its guaranteed investment contract [a way of parking cash, often the proceeds of bond sales, somewhere it will earn a tasty yield but suffer to likelihood of loss of interest or principal] franchise. What's curious about this move, is that its addressing a worry that people had about MBIA's portfolio.

Standard bond insurance caveats: No sign that the insurers can't meet their obligations. There's always the possibility that Moody's lead monoline analyst, Jack Dorer, or his counterpart at S&P will wake up one morning and decide to unleash financial meltdown before breakfast. No idea what the terms of this line of credit are, and under what conditions it might be withdrawn.

But again, $5 billion. For what was until recently an also-ran bond insurer. That had been really conservative, and certainly not encountered the slightest whiff of a downgrade. That, according to this presentation, had GIC commitments to structured finance deals that exceeded its commitments to muni deals. That, of its roughly $19 billion investment portfolio, $13.5 billion is parked in residential mortgage-backed securities, and of those RMBS holdings, almost $8 billion is first lien subprime. Ah. Maybe this was what Ackman was referring to.

Further caveats. I'm sure that the RMBS that FSA has bought is the really fragrant type in the three US markets where the real estate isn't tanking, and on which the structural protections afforded to the insurer are really tough. And the investment portfolio will not be called on all at once.

But I give in. Maybe the monolines' eternal quest for yield will send us to our doom. Maybe it will emerge that Assured has been spending Wilbur Ross' money on MC Hammer-esque fripperies. Maybe the new shape of the monoline business is capturing spread on a small number of muni deals and spending the rest of the day playing golf with the ratings agencies.

But the capacity of the balance sheets of a group of insurers, which I've always maintained are in an easy-to-understand business, to surprise me is truly frightening.


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