The Monolines Need $200 Billion? No Way 10 comments
Tom Brown
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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.
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This article has 10 comments:
Thank you for your insight. Keep it coming!
The monolines currently guarantee securities with a face value of $2.4 trillion. Of that, $1.5 trillion are municipals.
Comment: Give me some proof that in fact 1500 billion of these are municipals because now I can only believe you on so called 'face value'. So please a bit more rigor facts and not that weird emotional ranting that defines lots of Americans.
Well Tom Brown, I have a habbit of backing up what I say.
For example I say that total debt that the US economy has on herself is above 50 trillion (or above 50,000 billion and if you write it out it is just 50,000,000,000,000 US$).
Here is the backing up, link:
www.federalreserve.gov...
For example the above link says that the combined US financial sector picked up from Q2 to Q3 2007 the next amount of debt:
15435.3 - 14855.0 = 580.3 billion more debt in just one quarter.
So we can talk long or short if they need 15 billion now and may be 200 billion in the long run but my basic argument is:
Back your stuff up!
seekingalpha.com/artic...
Ah ah, CountryWide while in those long lost months Alan Greenspan was still stating that the US housing market was only local and not country wide...
Here is a quote from the above linked article, quote:
I think Countrywide is carrying a much larger burden than it should because we are number one. I came from Ameriquest to Countrywide and I can tell you that it is night and day when it comes to ethics. We get weekly "ethics scenarios" that every employee must complete. We have posters all over the walls preaching ethics. We couldn't get a subprime loan that should be prime through underwriting if we tried. Every subprime loan is run through Fannie Mae's Desktop Underwriter system to determine whether or not it would qualify for an "EA" prime loan. And if it does, we are mandated to sell the 30-year fixed EA loan, even if the subprime 2/28 or interest-only loan provides a lower monthly payment.
I wish more journalists would do their homework instead of taking jabs and spinning things to sell more papers. Unquote.
Comment: In case you have invested in Tom Brown's hedge fund stuff it is advised to scale down a bit... The guy simply does not understand the macro economic details the USA is in.
Regardless, my point was that it is refreshing to see something quasi-positive, if not sensible, regarding the plight of the bond insurers. I don't know Mr. Brown, nor do I know his background, but I'm in his camp on the validity (or lack thereof) of Gross, Egan and Ackman's numbers. In fact, their combined temperment on the subject verges on fanatical, to the point I question if they individually have exceedingly large short positions on the Insurers(?).
Is Mr. Brown correct in his allegations and position on the matter? *shrugs* Only tell will tell, I suppose.
I would love your insight on Advanta. By my calculations, the stock is worth somewhere near the $20 mark. On an adjusted book value without any future revenues the company is easily worth $11. If you start with their balance sheet and assume that their CDO investments are completely written off and then assume that 9% of their receivables are charge offs (in the 00-01 recession they reached as high as 7.5%) the $13 book value becomes $11. Off balance sheet their securitization portfolio has an average net yield of 4.5% (if charge offs approach 9%, then there are still no losses - only a drop in the total income from securitizations of 0 (which is reflected on the income statement). So now we are left with $11, now lets assume that their net income stays at $70m after 2 tough years and you capitalize that income at a 15% cost of capital - you get an additional $9 a share. So back of the envelope this company is worth way more than the current market price. It basically comes down to this, if you dont like Advanta at current levels then you pretty much are making a bet that the economy is going to completely fall off a cliff which would make the S&P drop a lot more than this already depressed stock (I'm actually long Advanta @ 6.80 and short @ 50 delta the S&P - so far it's working out great). Another thing to consider is that Advanta lends to small businesses - we run several small businesses and can tell you that any purchase we make on a credit cards (Advanta of course) we do to manage the receivables cycle or as investment (we arent buying useless electronics like the consumer card customers) and our credit card expenditures are part of our debt calculations so we dont spend what we shouldnt. I think a lot of businesses are this way. So you could definitely see a rise in delinquencies past 30 days (as you did see in December) but it is also possible that the small businesses slow down and pay down their debt burden on their cards as they receive payment. It is also possible that Advanta's spread increases as Libor spreads come down and credit card rates increase. Am I absolutely crazy about this or are people so hysterical about financial stocks that they are crapping on everything? I mean if I had all the money in the world, I would buy the entire business and be a very happy man. There are very few stocks I can say that about and it's been quite some time that the environment has looked so good for those who like to invest based on intrinsic value and not relative value. I guess everyone will keep on second guessing and mistrusting financial institutions until the whole monoline issue is further understood even if it doesnt affect every financial stock.
business.timesonline.c...