Monoline Duoline Rescue Plan: 5th Time the Charm?

US Equity markets were ending last week on a down note, when rumors of an Ambac (ABK) rescue plan started circulating (via Charlie Gasparino of CNBC).

A few issues seem to be getting overlooked in the kneejerk reaction to this. Let's see if we can identify some more interesting elements:

1) This is the fifth such rumor in 2008, and I'm not sure why that is. Is it wishful thinking, or have the other deals fallen apart -- for good reason, too?

We had the initial rumor over a month ago (Next on the Worry List: Shaky Insurers of Bonds); that was a $15 billion dollar bailout. Then came the Wilbur Ross Ambac rescue plan. Another bank consortium plan came and went. Lastly, the Buffett offer, which was widely misrepresented as Berkshire (BRK.A) injecting money, when Buffett merely offered to sell reinsurance to the monolines duolines.

2) The current rescue operation is for but $3B. This small sum is intriguing -- not just relative to the prior rumors. First, the duolines have potential exposure anywhere from $30 to $75 billion dollars. On top of that, the bank's counterparty and hedging exposure has been estimated at $150B to $200B. Can $3B really solve this problem?

3) From the FT Friday: Banks to aid Ambac with up to $3bn

The banks looking at supporting Ambac include Citigroup (C), Wachovia (WB), Barclays, Royal Bank of Scotland, Société Générale (SCGLY.PK), BNP Paribas, UBS (UBS) and Dresdner. They have the most exposure to guarantees supplied by Ambac on structured bonds and derivatives, the value of which could fall sharply, resulting in billions of dollars of writedowns if the insurer's credit ratings drop far below the triple-A level. (emphasis added)

Hence, the banks who are Part of the rumored consortium are (of course!) the ones who have the most to lose if any of the Duolines fail. This is not so much a bailout as a possible attempt to kick the can down the road. They have the most exposure to guarantees supplied by Ambac on structured bonds and derivatives, the value of which could fall sharply, resulting in billions of dollars of writedowns if the insurer’s credit ratings drop far below the triple-A level.

What's truly bizarre is that a dozen banks spending three large may actually be a relatively good deal for them, if it avoids a quarter trillion in writedowns.

4) Coincidence or good timing? Look who's expected to report writedowns this week: Fannie Mae (FNM), Freddie Mac (FRE), Lehman (LEH), Morgan (MS) and Goldman Sachs (GS), and Royal Bank of Scotland.

The bottom line: Until this deal gets done and the details are better known, it's simply another in a long string of rumors. Worse yet is what it means: Banks have so much derivative exposure they are willing to throw away $3 billion to prevent the counter-parties from getting a ratings agency downgrade.

Source:
Banks to aid Ambac with up to $3bn
Aline van Duyn and Ben White in New York
Fri Feb 22 19:25:37 EST 200

Comments

[Mighty:]

Great artical,I agree 100%,how can so little(3B) cure such a huge problem and how can S+P give them a Triple A ratting and then say it's a negative one.Wow,then the market jumps 180 points.This rally will fail as the problems are only just begining with 2 more years of resets.I am real agent in San Diego and most of the home buyers used 80-20 no qual loans,so it is easy to see why they are walking away from homes that have no value to them.These loan are just beginning to fail and the banks will be writting off far more than they have so far.

2008 Feb 25 08:22 PM

[NARSpin:]

This is just another suckers rally drawing in some more "bottom fishers" trying to time the bottom. I almost feel sorry for them. It's actually good to shake out these players - as it will eventually allow a real bottom to form.

2008 Feb 25 09:17 PM

[j.lauberge:]

With all due respect,your analysis is way behind the curb...and so is C's Gasparino's...both of you fail to comprehend the nature of insurance... nobody likes paying premiums untill something goes wrong..accidents happen often caused by complacency..hing bad happens, you're glad you have insurance..the current problems facing the monolines is a blessing in disquise...it is the giant red flag and first line of defense against a economic sunami if the CDO problem does not get contained!..if the bond insurers fail the banks could be next...The point is the treasury knows that the problem must be addressed now and diligence and recapitalization now should help all the financial markets in the future! So all of you
ragging about the bond insurers might start looking at the potential legal liabilities looming for Wall Street's biggest firms is something isn't done to start lifting the CDO's..for example investments that were sold by Merill Lynch to the city of Springfield Mass for 14.2 million and recently were marked down to 1.2 million...Maybe you would rather talk about Goldman Sachs who during the boom years sold subprime to it's institutional investors while betting against them for their trading accounts...funny that subject never gets discussed!! Bottom line banks,brokers, insurance need to all start raising money for the financial industries and get it from other areas like tech...because if this problem continues, look out below for all Stocks! keep your fingers crossed!

2008 Feb 25 10:00 PM

[Johnny Bitc...:]

Of course there is a reasonable likelihood that the injection only delays the downgrades instead of preventing them from occurring. In this case the banks calculation becomes more uncertain.

My personal view is that it would take an enormous injection, greater than 3 billion to prevent Ambac from being downgraded at some point in this slowdown.......

jbd.

2008 Feb 25 10:53 PM

[Ginger Yellow:]

"The current rescue operation is for but $3B. This small sum is intriguing -- not just relative to the prior rumors. First, the duolines have potential exposure anywhere from $30 to $75 billion dollars. On top of that, the bank's counterparty and hedging exposure has been estimated at $150B to $200B. Can $3B really solve this problem?"

Well, S&P puts Ambac'scurrent capital shortfall at just $400m, so in principle there's no reason why $3bn wouldn't be enough to save its AAA rating (assuming Moody's is roughly of the same opinion). Of course, whether or not it's enough to restore investor confidence is another matter.

2008 Feb 26 08:38 AM