Thursday, August 14, 2008 3 comments ++[ CLICK TO COMMENT ]++

Some (Minor) Positives on the Horizon for Some Bond Insurers

WSJ MarketBeat blog has an entry quoting Duff & Phelps pointing out some benefits for the bond insurers from the ARS deals being cut by the banks:

Bond insurers have helped some debt issuers convert auction-rate securities to variable-rate demand bonds or long-term fixed-rate notes, which has given some business to insurers that have seen the market for their guarantees dry up in recent months.


There is no consensus as to how banks will manage auction-rate securities they will hold in their own portfolios, but a move toward converting the securities is one potential strategy, said Batchelor.

Bond insurers could also gain if securities are redeemed by the issuers and the insurance policy is canceled. The cancellations free insurers from potential liability for the debt while allowing them to book the entire premium as income immediately.

All of this is minor and it is not clear what the banks who take the ARS onto their balance sheets will want to do. However, a few million here and there can add up, while reducing their exposure (not that the rating agencies seem to care.)

According to some such as John Dizard, the monolines also hold some precious keys that vultures may want (thanks to Alea blog for original mention.)

As our workout person continues: “The last of those mortgages were issued in the first quarter of 2007. Most of the speculators and renters have defaulted, and now we are down to dealing with the real people. The bankers privately think the pools covered by the (toxic) CDOs will have a loss rate of 23-24 per cent, nationally. That makes the paper worth perhaps 74 cents on the dollar. Lone Star bought Merrill’s for 22 cents.”


A triple, eh? But there’s a catch. You cannot liquidate a CDO insured by a monoline, which many were, without unwinding the insurance contract. The monolines do not have to pay out losses for many years. The monolines have what are called “control rights”, and that is the key to our speculation.

Control rights, when sold to a vulture or back to the insured, turn the smelly, written-down, Wall Street-and-regulator-hated CDO into a treasure house of value. All of those scrimping, two-job, rehab-graduate homeowners can now send their monthly cheques to Vulture Partners LLC. The number on those control rights will vary, but in the Merrill Lynch-Lone Star-SCA case there was a writedown of $528m (£267m, €340m) on a previously booked $1,028m insurance contract. That difference goes to the net worth of the insurer, and, prospectively, to the shareholders.

Again another minor item but it does have some value. You cannot crack open a CDO without monoline approval so there is some leverage for the monolines there. This isn't going to the save the monolines but it can be very strategic at times--sort of like owning a Knight in chess.


3 Response to Some (Minor) Positives on the Horizon for Some Bond Insurers

August 14, 2008 at 4:27 PM

Well, things definitely look like they are moving the monolines' way. Even the bears are beginning to see that 2006 vintage subprime losses are burning out with the class of '07 close behind (Synchro's guru John Hempton apparently even bought Ambac on that basis).

MBIA actually posted good numbers (and there as well as in Ambac's numbers you can already see the effect of the contract terminations on, among other things, ARS that you mention. Insured amounts are coming down quite fast and earned premiums are up substantially, thus the excellent operating profit for MBIA.

Terminations of insurance is likely to happen in many cases even without the vulture investors (Merrill reserved $1.5 billion to cover for book losses on upcoming insurance terminations, expect deals to be announced in the near future, probably with MBIA, Merrills main insurer). The vultures might make the process faster though. If Ambac can actually get Connie going with a AAA by october (seems wildly optimistic to me, but the CEO seemed rather confident of that timeline) this could be a surpisingly fast turnaround (knock wood!).

Meanwhile the spotlight shifts to prime and alt-A loans going sour at an increasing rate. No fun for the banks but monoline exposure in that area seems modest.

Oh Synchro, BTW how is your gold doing?

August 14, 2008 at 4:37 PM

And in an afterthought, the more I think about this MBIA vs. Ackman lawsuit round 2 the more I like the idea. Will be great to see how Ackman "explains" his constant claims of MBIA insolvency and imminent bankruptcy while his own analysis says company is fine (but suffering a big loss). Great spectator sport too! Will Jay Brown finally bite the dust? Will William Ackman blow up his second fund? Will Eric Dinallo call the sqaubling children to order? Stay tuned!

August 14, 2008 at 9:42 PM

The fact that Ambac still booked $1 billion as a loss keeps me concerned.

The Alt-A situation is not encouraging. Monolines still have exposure to alt-A and prime in their so-called "high grade CDO". But losses on those, even if elevated, will be nothing like subprime. In any case, the most toxic--the CDO-squareds--have been conservatively reserved by Ambac so now it's all down to the economy and a few losses here and there...

I have to disagree with you about suing William Ackman. I was thinking about making a post about it and will try to flesh out my views. My views are based on the notion of freedom of speech and I have seen nothing from William Ackman to indicate anything illegal or immoral. And remember that I'm on the opposite side of his trade and losing big time, so this isn't some pro-Ackman view. Let's go into that later...

Post a Comment