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The end of MBIA and Ambac?

Moody’s downgrading of MBIA and Ambac should be a cathartic event.

It means that the companies - in current form - will not write business ever again.

MBIA has been downgraded all the way to A2. It. is. not. a. viable. bond. insurer. Why? Well for a start, the underlying ratings on most of the bonds MBIA wraps - certainly the muni ones - are in many cases already better than that.

Ambac is at Aa3, which isn’t much better. Why would you pay to have your bond guaranteed at Aa3 when - put simply - Warren Buffett can do it AAA?  Everything else should - theoretically - be moot.

None of the above, however, stops MBIA’s management from treading water - and involving themselves in a war of words between the great and the good of the blogosphere. A bit of background to all this, here, but in polar terms, of the heavyweight bloggers, Felix Salmon has been in the monoline’s corner, while Yves Smith has been on the attack.

As FT Alphaville noted yesterday, it’s now clear that - pace NYT - Eric Dinallo and the NYSID are fairly limited in the scope of the regulatory actions they can take against the monolines. The risk being that in doing anything, Dinallo may trigger termination clauses in CDS contracts and cause a run from policyholders.

So the issue is if Dinallo need do anything. If he did need to step in, then MBIA’s decision to withold $900m at the holding company level - the subject of a tangential debate between Smith and Salmon - would suddenly be relevant once more, since it would be needed - perhaps - to meet termination charges caused by desperate policyholders.
It’s been said that policyholders wouldn’t run on the bond insurers -the comparison being made to ACA. But as Yves Smith points out, comparisons to ACA are something of a canard.

Banks granted a stay on ACA contracts because otherwise ACA would go bankrupt: ACA had defaulted on huge margin calls on CDS on CDOs. If the banks didn’t waive those margin calls, and ACA went bust, then the swaps written with ACA - used to hedge huge CDO positions on the banks balance sheets - would be worthless. Resulting in massive writedowns.

In the case of MBIA and Ambac, we’re not talking about bankruptcy or margin calls. Indeed in many cases, the value of the insurance written is already worthless - in the case of MBIA, many wrapped bonds have an underlying rating now higher than the wrapper. Policyholders, in other words, have everything to gain from terminating the insurance contracts.

The ball then, is in Dinallo’s court. Anything MBIA or Ambac say is smoke and mirrors. The situation is out of their hands.

And the major factor weighing on Dinallo’s mind will be the solvency - and regulatory capital adequacy - of MBIA and Ambac. The NYSID spoke at length to Felix Salmon. Here’s some of what they said:

We think there’s enough money to pay all the claims based on what the current expected losses are. Things have deteriorated a little bit, but whatever gauge you want to use, the current claims-paying resources in the industry for MBIA and Ambac are going to be sufficient to pay all the losses on the policies they wrote. 

Cause for succour? No. Because “current expected losses” are on an upward trend. And what is the prime mover behind that trend? RMBS performance.

The rating agencies hold all the cards here: for once - ironically - they are leading indicators.

This entry was posted by Sam Jones on Friday, June 20th, 2008 at 10:58 and is filed under Capital markets. Tagged with , , , . You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.

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Comments

  1. Jun 23   10:10 Posted by KAS [report]

    Maybe I’ve missed something (like the fine print in monoline agreements) but why is it a given that a company that has a lower rating than the asset it is guaranteeing MUST DEFAULT BEFORE that asset defaults? The arguments claiming the monolines guarantees are worthless imply this relationship must exist.

    The guarantee becomes worthless, from an economical point-of-view, the minute you believe they won’t be around when you need to call on that insurance. This might happen, i.e. a monoline default, before, after or at the same time the guaranteed assets are defaulting – i.e. it’s an issue of joint default probability.

    The value of the guarantee decreases with the guarantors ratings but doesn’t evaporate at the magical point of the underlying asset’s rating. Even a guarantee from a CCC counterpart carries some, albeit very small, value.

    However, if you are talking about the value of the guarantee as a tool for reducing the capital charge, I agree that, for most institutions having to consider capital charges, the rating of the underlying asset is the point where the guarantee becomes worthless, should the guarantors rating fall below that particular point.

  2. Jun 20   20:20 Posted by yap [report]

    Insurer wins because he receives premium every period for covering nothing. Insurance is worthless means underlying asset is highly rated than the insurer, it means the probability insurer defaults is greater than underlying asset.

  3. Jun 20   18:14 Posted by Research Recap » Blog Archive » Research Zeitgeist: The end of the monoline? [report]

    […] 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 (NYSE: ABK) and MBIA (NYSE: ABK). 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. […]

  4. Jun 20   17:07 Posted by D Merkel [report]

    “In the case of MBIA and Ambac, we’re not talking about bankruptcy or margin calls. Indeed in many cases, the value of the insurance written is already worthless - in the case of MBIA, many wrapped bonds have an underlying rating now higher than the wrapper. Policyholders, in other words, have everything to gain from terminating the insurance contracts.”

    My last post got eaten by the HTML, so I’ll try again.

    Guaranteed obligations should be rated at the greater of the guarantor’s rating and the underlying rating. If the guarantor is worthless, terminating the insurance contract isn’t necessary, and there might be a small loss in doing so, because there is the unlikely possibility that the guarantor could recover to a rating above the underlying.

    That said, the problems here will have a bigger impact on structured products than on the municipalities… the municipalities will survive; it is the those who have insurance on structured products that will have to fight over the corpuses of the guarantors.

  5. Jun 20   16:35 Posted by D Merkel [report]

    >>In the case of MBIA and Ambac, we’re not talking about bankruptcy or margin calls. Indeed in many cases, the value of the insurance written is already worthless - in the case of MBIA, many wrapped bonds have an underlying rating now higher than the wrapper. Policyholders, in other words, have everything to gain from terminating the insurance contracts.

  6. Jun 20   15:45 Posted by Stacy-Marie Ishmael [report]

    @jck - rhetorical questions don’t require answers…

  7. Jun 20   15:21 Posted by The Capitalist Resistance [report]

    More Downgrades for MBIA, Ambac…

    FTAlphaville - Moody’s downgrades Ambac, MBIA & The end of MBIA and Ambac?

    Are these downgrades the proverbial nails in the coffin?
    ……

  8. Jun 20   14:59 Posted by MBIA and Ambac have probably just passed away | Risk and Return [report]

    […] Suggested readings:The end of MBIA and Ambac?, Downgrades Come Easy, Upgrades Come Hard, Upgrades to AAA? — Forget It., On the MBIA, Ambac Downgrades; Regulatory Comments on MBIA, MBIA Downgrade Increases Collateral Requirements; Clarification on CDS Acceleration in Insolvency/Custodianship, MBIA: Moody’s Twists the Knife

  9. Jun 20   13:36 Posted by jck [report]

    just a question, if you buy insurance and it becomes worthless, who is winning you or the insurer ?
    looking forward to your answer…

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