Specialist bond insurance companies such as MBIA and Ambac face a moment of reckoning in the coming weeks, reports the FT on Monday.
Moody’s and Fitch ratings agencies will shortly complete their reviews of how such companies are rated, and might conclude that mortgage losses have put the insurers’ triple-A rating at risk.
But the bond insurers’ quest for new capital to secure their triple-A status could face significant challenges amid limited investor appetite for companies with exposure to structured securities backed by mortgage debt, the FT warns.
Ken Zerbe, analyst at Morgan Stanley, told the FT: “Both MBIA and Ambac will need to raise capital in order to support their AAA ratings and avoid a ratings downgrade”. And even if they can avoid raising capital in the near-term, they will continue to face capital pressure as the subprime meltdown worsens, he added.
The fate of bond insurers has emerged as a crucial concern in the credit crisis. These companies insure thousands of billions of dollars of debt, including securities backed by subprime mortgages, but hold relatively little capital to back these guarantees.
Moody’s on Wednesday waved a red flag by saying that losses on mortgage securities meant MBIA was “somewhat likely” to reveal a capital shortfall, sending its shares almost 16 per cent lower. The credit-rating agency warned that other bond insurers Ambac, FGIC and SCA faced similar risks of capital shortfalls, and that CIFG was “most likely” to fall below capital benchmarks for the triple-A rating.Losing its triple-A status would endanger a bond insurer’s ability to guarantee debt, its main source of revenue. MBIA responded to Moody’s by saying it had been “pursuing capital contingency plans” to improve its financial standing, “even in the absence of any immediate rating agency requirements”. Analysts’ estimates for how much capital MBIA might need range from $3bn to $20bn.
Other bond insurers are also understood to be looking at ways to raise new capital.
But while these groups, also known as monolines, are likely to do everything they can to maintain their ratings, analysts believe raising capital might be challenging given current market conditions, the FT says. “They’ll all end up retaining the triple-A rating, but at what price?”, Andrew Wessel at JPMorgan told the FT.
The bond insurers might secure more capital by raising new equity, while reinsuring their portfolios would allow them to free existing capital. Other options could include temporarily halting new business and relying on existing revenue streams, which would allow some of its insured securities to mature.
But this may not be quick enough to avoid a downgrade.
Industry capacity for reinsurance of riskier structured securities such as mortgage bonds is limited, says Morgan Stanley’s Mr Zerbe. Recent equity market weakness has also greatly diminished the ability of publicly traded bond insurers to raise capital in the equity markets.
MBIA’s shares are down by 60 per cent this year, while Ambac’s have fallen almost 70 per cent.
Short interest in both companies has risen by about 50 per cent in the past six months, as investors bet that the insurers’ capital resources may be insufficient to meet claims on insured mortgage bonds.
Michael Cox, an analyst at RBS, says a combination of options is likely to be needed with reinsurance as a first step, together with writing less aggressive new business and raising fresh equity or subordinated debt capital.
One final option – perhaps the most viable – would be for the bond insurers to find strategic buyers to inject new capital through a private placement.
In recent weeks, CIFG became the subject of the first co-ordinated bail-out of a bond insurer, when two leading French banks pledged $1.5bn to prop up its credit ratings. Caisse d’Epargne and Banque Populaire will buy the bond insurer from Natixis, the French investment bank that itself is controlled by the two mutuals, and then inject the $1.5bn to enable it to maintain its imperilled rating.
At the heart of the matter is the fact that bond insurance is a “confidence game”, according to Robert Haines at CreditSights, the independent research group. As a result, he says, even if the bond insurers have viable options for capital raising to avoid a downgrade, the sell-off in the market could become a self-fulfilling prophecy.
“If the markets lose confidence in the ratings of the sector, the value of the product being sold disappears,” he says.