Monowhine II | FT Alphaville

Monowhine II

This thing is over already, the market just doesn’t know it yet.

– Bill Ackman, speaking on Wednesday in New York.

He refers, of course, to the continuing existence of the monolines. Though he could equally be talking about his own involvement with them – since he’s widely believed to have closed out his shorts on Ambac and MBIA already.

Hold hard, though, as according to Bloomberg, Ackman is now shorting FSA (another monoline, as yet to lose its AAA).MBIA meanwhile, has been vigorously defending its position in the wake of a NY Times article. In obfuscation terms, it’s a class act. An FT Alphaville roundup here.

Granted, the NY Times article is less than clear in places. But MBIA do not tackle adequately the article’s central thrust: that in the event of Eric Dinallo, and the New York State Insurance Department stepping in and taking MBIAs insurance subsidy into receivership, policyholders will have the right to terminate their CDS agreements and demand payment: causing, effectively a run on the insurance company.

All of that is laid out in the ISDA protocol. In clause 4.5 of the the Monoline supplement agreement, it states that the CDS agreements are subject to…

…applicable bankruptcy, reorganization, insolvency, moratorium or similar laws affecting creditors’ rights generally and subject, as to enforceability, to equitable principles of general application.

If Dinallo moved in on the bond insurers, then, the NYT seems quite right in highlighting that there’s plenty of legal room for those CDS contracts to be challenged. Law firm Linklaters put out a note illustrating just how little a regulator need do in terms of intervention to trigger termination under the clause.

So nevermind the huff about “inaccuracies” at the NYT and whether termination payments may occur if Dinallo steps in – there are just two viable defences for the bond insurer. Firstly, that they’re solvent, so there’s no question of Dinallo moving in on them in the first place. Secondly, that even if Dinallo did step in, most policyholders would not rush to terminate. As in the case of ACA, it’s likely that they’ll see sense and waive any such rights – preferring run-off to run on.

The second point is probably where MBIA is right. But on the first – the question of solvency, things aren’t so crystal clear.

Felix Salmon at Market Movers is certainly supportive of MBIA’s own stance on the matter:

For one thing, there’s a world of difference between losing your triple-A rating, on the one hand, and being forced into receivership, on the other. MBIA is a double-A rated corporation, which puts it on the same level of creditworthiness as the world’s strongest banks… In other words, we’re still a very long way from MBIA going bust.

But MBIA need not go bust; simply breach its regulatory capital requirements. That could quite easily be considered a dealbreaker under the ISDA terms. And MBIA is not all that far from breaking those regulatory levels – or at least, not as far as its strident PR makes out – double A or no double A. As Bloomberg reports: 

In the past two quarters, MBIA’s insurance unit set aside reserves of $2 billion to cover losses on $51 billion of guarantees on home-equity securities and CDOs backed by subprime mortgages.

Ambac booked about $2 billion of loss reserves, leaving it with a statutory surplus of $3.6 billion. It guaranteed around $47 billion of CDOs and home-equity debt.

While both companies are above the regulatory capital requirements, S&P said in a February report that in a “stress case scenario,” MBIA may be forced to pay a total $7.9 billion in claims on a present-value basis and Ambac may be forced to pay $6.2 billion.

A stressed scenario such as, for example, continuing downward trends in RMBS. The question then, is how bad the economic situation could get.

Which is to say, the NY Times article was certainly alarmist, but may not be – as MBIA et al would rather have you believe – so totally wrong.