The monolines aren’t looking very mono anymore. Except perhaps in a nasty, sickly way.
Everyone seems to be after a split now - even if they’re not sure how they’d like it to happen.
But forget a bisection of the municipal and structured finance units of the largest bond insurers. Come-back chief executive Jay Brown of MBIA has told the FT that he thinks we could be talking about a three or four way division.
Consider this exchange from the FT’s View from the Top video interview:
Is it inevitable that the municipal bond business will be split from the structured finance business.
I know what we’re going to look like in five years.
And you think it will be that split?
I think we are going to be split up into three or four different businesses. The market, the complexity, the cost of getting capital when you’re under stress says, “I’d rather be modestly capital inefficient by operating in different businesses if it makes it easier for the outside world to understand us.”
Is there further potential for splitting in a “good bank/bad bank” fashion? Do we need a bad bank and a really awful bank option? Or is the third business an asset management one, in which MBIA has $66bn of fixed income assets under management?
In fact, MBIA is all about splitting. The company on Thursday severed its ties with the Association of Financial Guaranty Insurers because the two no longer share a common view of the future of the industry. Brown again:
we believe that the industry must over time separate its business of insuring municipal bonds from the often riskier business of guaranteeing other types of securities, such as those linked to mortgages.
But how? MBIA spent part of this week criticising the new proposal made by noted monoline shorter Bill Ackman (now available online, HT to Felix Salmon). They cited a New York State Insurance Department spokesperson:
“Mr. Ackman’s plan splits the company and would likely lead to a substantial downgrade for the structured side, which would be bad for the banks.” He said, “We would prefer a transaction that maintains a top rating for the entire book, and that is what we continue to work towards.”
So MBIA is paying lip service to the idea that they can’t favour one class of claimant over the other. But how they’ll do that remains unclear. For a start, as its chief executive hinted at above, two (or three or four) separate businesses will require greater capital underpinning than in one combined entity. And what has always been rather unclear in the bond insurer split plan is where the reserves go.
Other alternatives are being thrown around - aside from Ackman’s which may or may not be motivated by a desire not to end up short of a muni bond insurance business after a restructuring.
Yves Smith passes on speculation about a plan that would see the rating agencies take another look at capital requirements for the muni business, freeing up capital to support the structured book. Such a move, he notes, would require a real volte-face on the part of the agencies, requiring a major backtrack on the levels of capital needed for the muni business and the idea that these entities are undercapitalised. Then again, the credibility and standing of the rating agencies is so shot through that anything, if it avoids downgrades leading to a widespread municipal meltdown, seems possible.
But the question of whether the monolines actually need to be AAA-rated across the board is gathering debate. Bank of America analyst Jeffrey Rosenberg on Thursday suggested a recapitalisation that stablised the monolines to the AA level could be sufficient. The key is avoiding a “marginally solvent” bad bank which could trigger $30bn in writedowns across financial institutions with monoline counterparty exposure. An AA solution could limit that to about $5bn.
The AA level hasn’t been chosen at random, explains Rosenberg:
The AA level limits the spread of systemic risk while reducing the amount of new capital required. Key to the necessity of maintaining the AA level, the floating rate tax exempt market held by 2a-7 money market funds contains ratings triggers limiting portfolios to no more than 5% in below AA rated instruments. With more than half the wrapped municipal universe underlying ratings below AA, a monoline downgrade below AA could prompt $200bn in short term muni paper hitting bank balance sheets1. Targeting the AA level would also reduce the risk of further capital requirements as loss expectations change. While the AA level may not make municipal bond holders whole, we note that the muni market already significantly discounts any value attached to a monoline wrap and that even after a breakup, due to the significant legal challenges and uncertainties, that value erosion may not be cured.
