The End of the Monoline Bond Insurance Business

The death rattle of the monoline bond insurance business as we have known it could be heard loud and clear this week, with Moody’s whacking in what looks like the final nail in the business model with its downgrades of Ambac (ABK) and MBIA (MBI). The companies may yet end up surviving, but not in anything like the same form. FT Alphaville offers a good roundup of their unraveling. The monolines’ travails puts credit default swaps in the spotlight, notably in how they might be treated in a bankruptcy scenario.

The Good (Goldman Sachs (GS)), the Bad (Morgan Stanley (MS)) and the Ugly (Lehman Bros (LEH)) survived their first quarter earnings announcements in decidedly varied shape, but the debate rages on as to how much more subprime and related writedowns and losses lie in store for them and other financial institutions. Subprime-shorting hedge fund darling John Paulson thinks banks are only about a third of the way through $1.3 trillion in writedowns and losses. Yet the OECD this week reiterated its estimate of eventual losses at $300-$400 billion in its latest Financial Market Highlights. The OECD argues that “mark-to-market” estimates are not always a reliable indicator and says that while such losses are quite substantial, “relating them to the size of the banking sector more generally they seem less burdensome.”

Also, a USD 400 billion loss would correspond to less than 2% of the USD 22 trillion US equities outstanding, and to a not very abnormal daily decline in the US stock market.

Part of the discrepancy among estimates likely lies in what is included, with lower ones limited to specifically subprime mortgage instrument losses and larger ones also including broader credit markets losses from automobile, credit card and other debt.

Evidence that more pain lies ahead came from Citigroup's (C) admission that it may have to take “substantial” subprime-related writedowns in the current quarter.

Persistent high oil prices appear to be driving changes in consumer behavior, including reduced automobile traffic (but increased online traffic) and a shift to more fuel-efficient vehicles. The big question is the extent to which these changes will stick, or whether consumers will revert to old habits once they adapt to higher prices.

Comments

[fxtrader07]

Bold prediction - little substance and reasoning. Given the deteriorating finances of the municipalities you will be surprised how they will have to scramble for bond insurance over the coming years or else face paying prohibitively high interest rates. There was a reason that a sharp-eyed and smart investor like Buffet committed significant resources to start his own bond insurer.
I have no clue whether MBiA will again write bond insurance (if, then in any case via a new subsidary) but to claim the "end of monoliners" might be a pretty premature call.

[Shorts.Distort]

To make such a forward looking (negative) prediction should be backed up with alot more facts,figures and reasoning , no a piece of hodge-podge recycled jargon.

[santasgift]

I remember when one of the sports commentators said it was over for Jack Nicklaus. He then quickly became the oldest person to win the Masters. You are way premature and sensationalist.

[Ishortyou]

In respect to AMBAC and MBIA, they need to keep and save all the cash possible including stop paying dividends, deleverage from all their risky liabilities specially those CDS, CDO's, RMBS-ABS of uncertain value, in order to remediate their book values, once their book values are sound they need to reinstate their triple A rating again to write new low risk public bond insurance business. They can also open or extend a line of credit to make sure to continue operations and dissipate doubts.

They are already doing these, so it will take some time to deleverage their books from uncertainties and rewrite new business again. This coming back will be the best advertisement to recruit new clients.

[oldlures1]

At a minimum, it's premature. In a broader sense, it's unsubstantiated propaganda. I regret that I expended time reading it.

[crashof2008]

One phrase in MBI's recent bland assurances that they have sufficient capital to meet the acceleration clauses on these swaps is that they have "10.2 billion in securities with an AVERAGE AA rating".

What does that hedge word "average" mean here? There are many ways to compute an "average".

For example, 10 bonds worth only 10,000 dollars each that are rated just one notch above AA "averaged" with 10 bonds worth 100 MILLION dollars rated just one notch BELOW AA would constitute such an "average" under this statement, even though the practical result would be that the vast majority of the alleged "collateral" is rated below AA.

Given MBI's record of dissembling, it seems highly likely that a large part of that 10.2 billion figure they cite is BELOW AA and will therefore be insufficient as collateral.

The key weasel fudge word MBI uses here is "average". Precisely HOW are they doing this "averaging"?

[mythoughts]

Ishortyou, why don't you change your posting. I've seen it at least five times. MBIA is over no matter what you say or want. Too bad for long holders.

[crashof2008]

Some of you have heard about MBI and ABK attempting to cancel 125 billion in credit default swaps in intense negotiations with Citibank, Merrill and UBS. Most accounts put MBI's share at 80 billion of this.

Any negotiations to cancel the 80 billion in insurance contracts that MBI wrote will be extraordinarily problematic, especially in this environment of collapsing bank profits.

To understand why, you need to master the difference between a CDO and a CDS. The difference between these two is an absolutely VITAL distinction that so many overlook.

I'll keep it short and sweet. But you need to master this distinction. Read carefully for just 30 seconds and it will serve you well.

Think of a CDS (credit default swap) as an insurance policy. MBI insured 80 billion of largely worthless paper to various banks. They are, after all, an insurance company and thought this would be a logical extension of their insurance business.

Now MBI wants the banks such as Merrill and Citi and UBS to cancel the insurance policies. MBI is basically offering to simply refund the premiums paid.

This would leave the banks holding 80 billion dollars of collateralized debt obligations (CDOs) that had been insured and guaranteed by MBI.

It's like if your house is destroyed in a fire. The insurance company, instead of reimbursing you for the value of the home (say $400,000) offers instead to rebate you the $1200 you have paid in premiums.

Would you take it?

This is what MBI is offering.