Bill Gross isn’t the only one throwing around wild and crazy loss estimates these days. Did you see that Egan Jones’s Sean Egan is telling investors that the bond guarantors need to come up with a whopping $200 billion to stay solvent? It is a ridiculously over-the-top number. To put it in perspective, the backstop fund that New York Insurance Superintendant Eric Dinallo envisions would come to something like $15 billion. To put it in further perspective, the low end of estimates for the all subprime-related mortgage losses, including the loans that didn’t find their way into CDOs insured by the monolines, is $150 billion.
So Egan’s $200 billion is way out there. I’m at a loss to understand how he came up with it, or why anyone takes it seriously.
Some numbers, and you’ll see why. The monolines currently guarantee securities with a face value of $2.4 trillion. Of that, $1.5 trillion are municipals. No one, not even Bill Ackman, looks for a crackup in those credits, and for good reason. Over the past 35 years, all of 41 municipal issues have defaulted. Roughly 99% of muni issues are investment grade on their own.
That leaves the insurers’ structured finance exposure at $900 billion. Of that, remember that not all insured paper is mortgage-related securities. And remember, too, that of the mortgage-related paper, not all is subprime. Again, no one is looking for a crackup of structured finance paper in general. The problems are with bonds backed by subprime mortgages, Alt-A loans, home equity, and closed-end seconds. The combined par value of that paper that’s backed by the guarantors came to $489 billion at the end of the third quarter, according to BCA Research.
So the guarantors’ subprime truly at-risk exposure is considerably less than $900 billion. And regardless, in the event of default, the subordination—extra collateral—already embedded in the securities will take the first loss. Beyond that, the guarantors will generate some recoveries in foreclosure.
But even if all the subordination in all the securities gets burned through in a heartbeat and recoveries are a pittance, guarantors exposure still won’t be anywhere near $200 billion. Here’s why: when an insured CDO goes into default, the insurer is not obligated to repay its principal immediately. Rather, it simply has to make interest and principal payments over the CDO’s remaining life. In many cases, that could take decades. Between now and then, the insurers’ payouts will consist of relatively modest annual payments spread out over many years. The present value of those payments is a tiny fraction of the face amount of the defaulted securities.
Who knows how much more capital (if any) the guarantors will have to raise? The rating agencies apparently don’t. (They seem to change their minds every week.) But one thing’s for sure: it’s nowhere near $200 billion. I can’t imagine how Egan Jones came up with that number. And I can’t imagine, either, why people can’t see that it’s nutty.
Tom Brown is head of BankStocks.com.