The story in today’s Financial Times, “Bond insurers want $125bn of cover wiped out,” seems more that an tad inconsistent with bond insurers’, particularly MBIA’s, claim that everything is hunk-dory with their financial condition and contention that the rating agencies were mean and capricious.
The story in brief:
Bond insurers such as Ambac, MBIA and FGIC are talking to banks about wiping out $125bn of insurance on risky debt securities in what could be the only way to limit the financial damage surrounding the bond insurers.
Discussions about “commuting” these insurance contracts, which were sold by bond insurers to banks in the form of credit default swaps, have taken on a renewed sense of urgency amid a rash of ratings downgrades in the bond insurance, or monoline, sector last week….
The talks centre on CDS contracts issued by bond insurers to guarantee payments on collateralised debt obligations, complex debt securities often backed by mortgages which have plunged in value amid a wave of foreclosures on mortgages issued in recent years.
I’m a little disappointed as to why the FT fails to mention why it is these exposures in particular that the bond insurers want to get out of. They repeatedly asserted that critics didn’t understand how these policies had been written, that in many (most?) cases they were not obligated to pay out until the underlying assets had reached final maturity, which could be twenty or thirty years out. Readers are encouraged to provide further insight.
The article also fails to mention that this move now may work for both parties given the downgrades. Any one who has bought an insurance policy in an insurer that has suffered a ratings cut is now paying for an overpriced product. For instance, someone with an MBIA guarantee signed up at a AAA rate and now has a A policy. And worse, the market is pricing it at Caa. So the policyholders should be willing to pay something to get out of the policies to save future payouts.
But can they agree on price? The banks may push hard, assuming insurer desperation, and may also be angry with being stuck with a turkey product. Insurers are notably pig headed negotiators. While in theory there should be a win-win resolution for at least some of these contracts, if the tone of discussion becomes adversarial, all bets are off.