Bond Insurer Death Watch: FGIC Loses AAA from Fitch; Ackman Estimates Losses for MBIA and Ambac Each at $11.6 Billion (Updated)

Bloomberg reports that hedge fund Pershing Square’s chief Bill Ackman has increased pressure on bond insurers and regulators by circulating a new analysis of potential losses to MBIA and Ambac, the two biggest bond insurers, that concludes the damage to each could reach $11.6 billion.

This calculation is arguably more accurate than Ackman’s previous estiimates, since it uses a model provided by an investment bank (they typically get the assistance of the firms the report on in developing their models) and list of CDOs and other securities guaranteed by MBIA and Ambac. Ackman posted the list on the Internet so others can make their own computation; this is the first time the list has been made available (some but not all of the instruments were known to be guaranteed).

Note that the publication of this information likely complicates the insurer rescue effort by instilling some nasty reality. Note that Ackman’s figures are merely the estimated losses; the bond insurers need to raise more than that to maintain their AAAs, which is the real purpose of this exercise. A downgrade to AA or even A is consistent with the insurers still being likely to be able to pay all their claims, yet would inflict considerable losses on the Street.

As we’ve reported in the last couple of days, some of the banks considering participating had been bandying about lower financial requirements than the $15 billion sought by Eric Dinallo; the bottom of the range was a reported $3 billion. They are now going to have to consider bigger numbers than some of them might have been prepared to accept.

Further pressure comes from the fact that Fitch announced that it has downgraded FGIC, the number four bond insurer, to AA, a reduction of two ratings grades. If I were a benevolent dictator, I’d have Fed worrying about the bond insurers and the adequacy of capital in the banking industry, rather than relying on and indirect and inefficient (and prone to side effects) remedy of monetary stimulus).

Update 1/30, 6:50 PM: My wording above may have been a bit oblique. The purpose of the bailout exercise is to preserve MBIA and Ambac’s AAA ratings from Moody’s and S&P (the other insurers, while included in the rescue efforts, are not where the main risk to the financial system lied). An AAA rating implies unquestionable financial capacity. Thus, any fundraising would not merely have to cover losses, but provide a large financial cushion beyond that. Egan Jones has put the total funding need at three times estimated losses, which some have argued is to high. But even if you assume only two times projected losses and you accept Ackman’s $23.2 billion loss estimate, that means Dinallo’s rescue effort is not seeking remotely enough capital.

Update 1/30, 10:00 PM: A reader sent me a copy of Ackman’s letter. I have only looked at it quickly, but a couple of things are noteworthy. First, the model considers only losses on RMBS and ABS CODs. Ackman’s earlier analysis also anticipated that there would be losses on MBIA’s commercial real estate and below investment grade guarantees, so this model may underestimate the downside for MBIA. Second, the Bloomberg story did not mention that Ackman provided two loss estimates for MBIA, the $11.63 billion publicized, and $12.6 billion “of one reincorporated certain 2007 CDOs of ABS that have been reinusred.” I haven’t read the full document yet, but I presume this relates to the possibility of non-performance of MBIA’s captive reinsurer, Channel Re.

First from the Bloomberg story on Ackman’s moves; later an excerpt on the Fitch downgrade:

MBIA Inc. and Ambac Financial Group Inc., the two largest bond insurers, may each lose $11.6 billion on guarantees of residential mortgage securities and some collateralized debt obligations, according to hedge fund manager William Ackman.

Ackman calculated the losses using a model supplied by an unnamed investment bank and sent the findings in a letter to the Securities and Exchange Commission and New York Insurance Superintendent Eric Dinallo. Ackman is a managing partner of Pershing Square Capital Management LP, which is trying to profit from declines in the stocks and bonds of MBIA and Ambac.

Ackman, 41, stepped up his attack by posting on the Internet a list of asset-backed CDOs and other securities guaranteed by Armonk, New York-based MBIA and New York-based Ambac that allows others to craft their own loss predictions. Ackman didn’t say how he got details on the securities, many of which haven’t been disclosed by the companies.

“Up until this point in time, the market and the regulators have had to rely on the bond insurers and the rating agencies to calculate their own losses in what we deem a self-graded exam,” Ackman said in a statement preceding release of the letter. “Now the market will have the opportunity to do its own analysis.”

MBIA fell $3.12, or 20 percent, to $12.86 at 3:42 p.m. in New York Stock Exchange composite trading. Ambac dropped $2.13, or 16 percent, to $10.80. Both companies have lost more than 80 percent of their market value in the past year….

Ambac said Jan. 22 it expects to pay claims on CDOs of $1.1 billion. MBIA said Jan. 9 it will likely report a $737 million expense for the fourth quarter to cover losses related to deteriorating subprime-mortgage securities it guarantees. MBIA is scheduled today to report its fourth-quarter results after the close of regular U.S. equity trading….

In a Jan. 18 letter addressed to the top executives of each ratings company, Ackman said they are underestimating potential losses at MBIA and Ambac by relying on after-tax results, failing to update ratings on reinsurers of bond insurance and ignoring the slide in the commercial mortgage-backed securities market.

In addition to MBIA, Ambac and Security Capital, the other AAA bond insurers are those owned or operated by Assured Guaranty Ltd., CIFG Assurance North America, FGIC Corp. and Financial Security Assurance Inc.

From the Bloomberg story on the FGIC downgrade:

Financial Guaranty Insurance Co., the world’s fourth-largest bond insurer, lost its AAA credit rating at Fitch Ratings after missing a deadline to raise capital.

Financial Guaranty, a unit of New York-based FGIC Corp., was cut two levels to AA, New York-based Fitch said today in a statement. The company had been AAA since at least 1991. Moody’s Investors Service and Standard & Poor’s are also reevaluating their ratings.

The loss of the AAA stamp jeopardizes ratings on bonds Financial Guaranty insured and limits the company’s ability to generate new business……

“This announcement is based on FGIC’s not yet raising new capital, or having executed other risk mitigation measures, to meet Fitch’s AAA capital guidelines within a timeframe consistent with Fitch’s expectations,” the ratings company said today.

FGIC is controlled by Walnut Creek, California-based PMI Group Inc., Blackstone Group LP, and Cypress Group. PMI dropped 27 cents, or 2.9 percent, to $9.16 in New York Stock Exchange composite trading. Blackstone fell 43 cents to $18.56…

About 71 percent of FGIC’s guarantees are on municipal bonds, 23 percent are structured finance and 6 percent are international transactions, according to the company’s Web site. FGIC guaranteed $21 billion of home-equity securities, $8.8 billion of subprime mortgage debt, and $10.3 billion of CDOs backed by subprime mortgages and other loans, the Web site shows….

Blackstone, based in New York, bought Financial Guaranty with PMI Group and Cypress Group from General Electric Co. for $1.9 billion in 2003.

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  1. RK

    Yves: I don’t know how widespread the awareness of his statement is, but Ackman has stated Publicly that he plans to DONATE proceeds of his short position (and this may be a PERSONAL short position, not Pershing Square’s ) to charity. Maybe
    Chico Marx was wrong when he said “there ain’t no sanity clause”.

  2. LittleBlackSambo

    S&P Lowers or May Cut Ratings on $534 Billion of Mortgage Debt

    Jan. 30 (Bloomberg) — Standard & Poor’s lowered or may cut ratings on $534 billion of residential mortgage securities and collateralized debt obligations.

    The securities represent $270.1 billion, or 6,389 classes, of mortgage securities rated between January 2006 and June 2007 and $263.9 billion, or 1,953 classes, of CDOs, S&P said today in a statement.

  3. eh

    A downgrade to AA or even A is consistent with the insurers still being likely to (sic) able to pay all their claims, yet would inflict considerable losses on the Street.

    What does that mean? — “consistent”. Does anyone seriously believe these insurers have the capital to pay likely future claims? As for any “rescue” effort, clearly it’s taxpayers who will likely be dragged into providing the capital. It’ll be sold as the lesser of two evils.

  4. Yves Smith

    Anon of 4:46 PM,

    Thanks for the link, hope to get to reading the paper this evening.


    Not aware of that, will mention it sometime. That is an important factiod.


    Thanks for the typo alert, and yes, perhaps my wording was too oblique. The point is that if you believe Ackman’s numbers, the required bailout level isn’t $11.6 billion. It’s $11.6 billion plus a very large (and we don’t mean a billion or two) cushion.

  5. tedb

    Yves, Is the Bloomberg article in error when it says that MBIA and AMBAC “may each lose $11.6 billion?” That would double the expected losses, right?

  6. Yves Smith


    Very important catch, and thanks for pointing it out. Bloomberg is now on update 4 of the story, and the earlier headlines didn’t state, as they do now, that the $11.6 billion estimate applies to each.

    It seems a little weird that two different firms with different business mixes and different sized balance sheets would have the same expected loss, which is why I made the mistake, since the prior work has come up with different estimates for each firm. But another reader had send me the letter that Ackman sent, and it does indeed say $11.61 billion for Ambac and $11.63 billion for MBIA “net par insured”; the MBIA losses rise to $12.56 billion if you include losses on certain reinsured risks (the reinsurance via Channel Re, MBIA’s captive, looks dodgy).

  7. Anonymous

    IMHO, Warren doesnt have the cash to play this game, as the game spins out of control: The New York insurance regulator took the initiative and called Mr Buffett’s Berkshire Hathaway, hoping it would enter the market.[16] NEW YORK, Jan 8 (Reuters) – Berkshire Hathaway Finance, a unit of Berkshire Hathaway (BRKa.N: Quote, Profile, Research ), sold on Tuesday $2 billion of notes in two parts in the 144a private placement market, said a source familiar with the deal.[17] Because of Berkshire Hathaway Assurance’s unprecedented reception by the states, notably, getting a license in New York in four weeks, “everybody’s expecting it to be AAA rated,” just as parent Berkshire is, Dunn said.[2]

    Warren Buffett’s Berkshire May Invest in Bond Insurer (Update4)

    Buffett’s bond insurer

    Berkshire Hathaway Finance sells $2 bln of notes-source

  8. Anonymous

    Re: ecause of Berkshire Hathaway Assurance’s unprecedented reception by the states, notably, getting a license in New York in four weeks, “everybody’s expecting it to be AAA rated,” just as parent Berkshire is, Dunn said

    The era of collusion and corruption!!!

    Berkshire Executives Knew AIG Would ‘Cook the Books,’ SEC Says

    David Plumb
    June 8, 2005

    June 8 (Bloomberg) — Executives at Berkshire Hathaway Inc.’s General Re unit knew four years ago that American International Group Inc. would use a reinsurance transaction to “cook the books,” according to phone transcripts cited in a suit from regulators.

    John Houldsworth, a former General Re executive who this week agreed to plead guilty to a criminal charge of conspiring to misstate AIG’s finances, discussed the planned transaction in a November 2000 phone call with the insurer’s chief financial officer at the time, Elizabeth Monrad.

    “They’ll find ways to cook the books won’t they?!,” Houldsworth told Monrad, according to a civil complaint the U.S. Securities and Exchange Commission filed on June 6 in conjunction with the plea agreement. The comment prompted Monrad to laugh, and then Houldsworth continued, “It’s up to them! We won’t help them to do that too much. We’ll do nothing illegal!”

    The SEC said in court papers that Monrad and Houldsworth, as well as General Re Senior Vice President Richard Napier and former Chief Executive Officer Ronald Ferguson, knew what was intended by New York-based AIG, which last month corrected its accounting on that deal and an array of other transactions. Warren Buffett, the billionaire chairman of Berkshire Hathaway, in April said the company will be judged by whether it has “knowing participation” in the misdeeds of clients.

    The transaction, which improperly boosted AIG’s reserves for claims, sparked an accounting investigation in October that last month led AIG to restate five years of financial reports and lower net income by $3.9 billion, or 10 percent. The deal also triggered AIG, the world’s largest insurer, to oust Maurice “Hank” Greenberg as chairman and CEO in March.

  9. Yves Smith

    Anon of 11:08 PM,

    Ackman has done far and away the best analysis. He has provided the model, which he calls the “open source” model, to the SEC and the relevant state regulators, It contains, by name and CUSIP number, their CDO and RMBS exposures from 2005 to 2007. This is vastly more information than Ambac and MIBA provided (a friendly global bank put the data together the hard way) and therefore better information that the rating agencies or regulators have possessed heretofore.

    He is encouraging everyone to combine their information. The regulators most certainly don’t have to report back to him. He wouldn’t be trying to force greater transparency if he wasn’t highly confident that it would work to his advantage.

    Ackman has also said he will give the profits from his short position to charity.

    From the letter:

    •The Open Source Model allows users to evaluate the losses of inner CDO collateral by looking at the specific collateral underlying each individual inner CDO rather than by using generalized assumptions. By failing to analyze the specific underlying collateral of all inner CDO exposures, we believe that rating agency loss results are understated by billions of dollars as these additional losses typically impair the AAA tranches guaranteed by the insurers dollar for dollar.

    •From 2005-2007, the total universe of ABS CDOs outstanding is comprised of approximately 534 deals. While MBIA and Ambac appear to have only limited direct exposure to this pool (having directly guaranteed only 25 and 28 CDOs, respectively), in fact, MBIA and Ambac are actually exposed to at least 420 and 389, respectively, of the 534 total CDOs outstanding if you include the CDO exposures within the CDOs they have guaranteed. The fact that MBIA and Ambac have direct or indirect exposure to 79% and 73%, respectively, of all ABS CDOs issued from 2005-2007 directly contradicts the insurers’ public statements about their “highly selective” approach to CDO guarantees.

    •MBIA and Ambac’s exposure to nearly the entire universe of CDOs also compounds their exposure to many other classes of RMBS securities with MBIA and Ambac being exposed to 3,131 and 4,179 unique tranches of ABS respectively. These large numbers of exposures will likely cause MBIA and Ambac to experience losses similar to that of the entire RMBS market.

  10. Anonymous


    Re: anon @ 4:46 & the paper; nothing really too grat there; save your time by reading this paste:

    The backtest procedure given by the Basel Committee described above has some
    serious shortcomings. It assumes that under the null hypothesis the exceedances (et )T
    are i.i.d. while empirical evidence shows a clustering phenomenon in the exceedances
    (see, for example, Berkowitz and O’Brien (2002)).

    The results indicate that this is indeed the case, and that, contrary
    to common belief, expected shortfall is not harder to backtest than value-at-risk if we
    adjust the level of expected shortfall. Furthermore, the power of the test for expected
    shortfall is considerably higher than that of value-at-risk. Since the probability of de-
    tecting a misspecified model is higher for a given value of the test statistic, this allows
    the regulator to set lower multiplication factors. We suggested a scheme for determin-
    ing multiplication factors. This scheme results in less severe penalties for the backtest
    based on expected shortfall compared to backtests based on value-at-risk, and the cur-
    rent Basel Accord backtesting scheme in case the test incorrectly rejects the model. In
    case of a misspecified model the multiplication factors are on average about the same
    for all tests. However, the multiplication factors based on the expected shortfall test are
    smooth and have low variance.

    There are newer better papers on backtesting, ill look around someday.

  11. Anonymous

    Does anyone have a link to the full Ackman letter and the list of ABS CDOs guaranteed by MBIA/ AMBAC? I’m searching around and cant seem to find it anywhere.

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