Ever since Eliot Spitzer threatened the troubled monoline insurers that he’d break them up, everyone has acted as if that’s a viable option.
But this talk of a split reminds me of movies about Hollywood, where someone buttonholes a producer with his pet idea:
“See, it’s like Flashdance, except you reverse it: the girl is a Hispanic ballerina who started stripping to pay her student loans….”
Like the film proposal, the break up notion is still at the high concept stage, little more than, “let’s separate the muni operations from the rest.”
And while admittedly Ambac has had only the long weekend to work on its plan, the update as of Monday evening via the Wall Street Journal suggested that the group is flailing around.
Consider: they’ve already backpedaled. Now Ambac wants to raise $2 billion first, then divide later:
Ambac Financial Group Inc. is discussing a plan to raise at least $2 billion in much-needed capital to help the world’s second-biggest bond insurer retain its top-notch credit rating, according to people familiar with the matter.
The extra cash, to be raised by selling shares to existing investors at a discount, would likely be a prelude to a trickier and lengthier move: splitting itself into two businesses.
Remember, Ambac was trying, like all the other bond guarantors, to raise money before Spitzer delivered his ultimatum. That went nowhere. But we are now back to Plan A, except with the break up idea added. But does that make investing any more attractive?
The answer is no. Before, you had a situation that was either going to end badly, if you believed Bill Ackman and the shorts, or was misunderstood and therefore perhaps a buy, if you believed the insurers. (Aside: my sense is no one has lifted the kimono enough for anyone to get a reading as to the exposures, which does not encourage investors). In other words, you had a high degree of uncertainty (how bad will the mortgage business get? How much capital might be needed over time to keep an AAA rating?), but it could be analyzed.
Now, Ambac is seeking to raise money. It hopes to split up, but gee, we aren’t certain we can do that, and even if we can, we aren’t exactly sure yet how this will work.
Is any one with any sense going to invest in a proposition like that? You have absolutely no idea what you are getting into. This whole discussion of a breakup plan has increased uncertainty enormously and raised the specter of litigation risk. Those are not exactly comforting to investors.
Why this volte face? Remember, the earlier plan, as of Friday, appeared to be “split ‘em up, we can raise capital for the good muni business, the hell with the rest.” Assuming you could segregate the muni operations, this plan might work. If MBIA could raise over a billion (albeit with a Warburg Pincus backstop), Ambac and its buddies might be able to stump up enough to pay the steep reinsurance rates that Buffett is demanding.
It appears they have discovered that they lack a legal basis for preferring the muni policyholders over the others, and even if they try not to prefer one group over another, it is going to be well nigh impossible to come up with a formula that won’t be contested. The Journal, along with others, sounded the litigation drumbeat:
Splitting the business between its municipal-bond and its riskier structured-finance operations…..would be financially and legally messy. It would pit policyholders and shareholders against both each other and regulators….
“It may sound politically convenient to separate out the muni business, but it’s going to invite a raft of lawsuits,” says Sean Egan, managing director at research firm Egan-Jones Ratings Co.
In addition, you have the minor detail that a break up may Destroy the World of Finance as We Know It. From Bloomberg:
Credit ratings on more than $580 billion of asset-backed securities may be cut, sparking writedowns by banks, under New York regulator Eric Dinallo’s plan to break up bond insurers….
“This is one of the worst possible outcomes for the market,” Gregory Peters, head of credit strategy at Morgan Stanley in New York, said in a telephone interview. Lower ratings would force banks that own the mortgage-backed debt to write down the value of the securities by as much as $35 billion, he estimated.
And that $35 billion is far from the biggest damage estimate we’ve read.
As we said, this split up idea never made any sense. If you talk to any dealer, say in estates, they will tell you that you sell items individually only if you think they will attract bidders (remember, the “good bank, bad bank” construct works because there are bidders for each portfolio).
If you have some items you think no one will buy separately, you put it in a lot with a few nice but not spectacular items. There is something weird about human nature, but generally a lot with more stuff in it will attract higher offers, even if the bidders really only want one or two items.
No one seems to expect that the “bad insurer” operations will attract investors. The comments from the regulators suggest the “bad” operation would be put in runoff mode. But that violates the rule of auctions above. The regulators would be more likely to get a good (or any) offer for the insurers in whole rather than in parts (as MBIA’s example confirms).
Now unless Dinallo and some brilliant lawyers comes up with a way to cut the Gordian knot (ie, they find a legal theory that permits them to discriminate among policyholders), we see a complete mess here. The split up idea has made matters, as bad as they were, even worse:
1. Ambac may have backed off the idea, at least until it has a legal basis for the breakup and a plan for how to accomplish it, thinking (as the Journal intimates) that the rating agencies won’t hold off their downgrades that long. But no investor with an operating brain cell will invest until the break up plan is fleshed out.
2. At least for FGIC, the way the breakup idea was announced angered the rescue group (such that it was, it hadn’t gotten very far). Ambac appeared to have had the most serious investor discussions, but the switch over last week to trying to shore up the muni business is of no interest to the banks who had been solicited before (remember, they wanted to rescue Ambac to save the “bad” part that is now being written off). Thus the most likely investors have been shooed away.
3. If Spitzer or Dinallo tries to force a break up on any of the insurers, they may encounter fierce opposition. The regulator has the authority to step if there is an impairment of the insurer’s ability to meet its obligations to policyholders. But what authority does he have to step in to avert a downgrade? I’d wager he has none.
Microsoft has long used FUD, Fear, Uncertainty, and Doubt, to paralyze its competitors. This bunch has managed to introduce a ton of FUD into something they want to move forward. Good luck.