As readers probably know by now, Moody’s, the last holdout on the AAA rating for the two big monolines MBIA and Ambac, downgraded both companies earlier today, and more harshly than Standard & Poor’s. And even with this downgrade, it underscored that more cuts are likely to be in the offing
MBIA’s MBIA Insurance Corp. unit was reduced five levels to A2 from Aaa, New York-based Moody’s said today in a statement. Ambac Assurance Corp. was lowered three steps to Aa3, Moody’s said in a separate release. The outlook on both is negative.
Standard & Poor’s now has both at AA, which is equivalent to a Moody’s Aa2 (Aa3 is lower than Aa2). Note that the ratings on the insurance subs are the ones of most concern to investors. Note further that Moody’s takes a dimmer view of MBIA than Ambac.
The rating agency underscored that questionable new business prospects are a major concern:
MBIA’s downgrade reflects its “limited financial flexibility and impaired franchise,” Moody’s analyst Jack Dorer said today in a statement. Ambac has “significantly constrained new business prospects” and likely will incur more losses, Dorer said.
This is a fairly blunt statement, and confirms the widespread view that the monoline business model has gone the way of the dodo bird. The free lunch of guaranteeing muni bonds that, were they rated on the corporate scale, in many cases wouldn’t need credit enhancement, is over. Municipal guaranteed will involve real risk assumption, a skill the monolines have not mastered.
With Warren Buffett offering a true AAA, most of the business worth doing will gravitate to him. And with doubts about ratings strength in play, what government body would sign up for a guarantee, designed to boost their rating, if a future downgrade may render it moot? ACA, which had only a singe A was able to write only $7 billion of muni guarantees out of a $70 billion portfolio.
Another part of the statement from Moody’s called the truthfulness of MBIA into question:
MBIA is $2.6 billion short of its target capital level for an Aaa company, Moody’s said. The rating company also said MBIA’s decision to retain $1.1 billion at its holding company was “indicative of a more aggressive capital management strategy” and contributed to the extent of the downgrade…
Ambac is $225 million below the Aaa target level, Moody’s said.
Sp the depth of MBIA’s downgrade is a self-inflicted wound. Had the monoline acted in accordance with its earlier promises, it would have gotten a higher mark.
But note specifically that the rating agency felt compelled to state the amount of capital MBIA needed to secure an AAA. Contrast this with the statement from MBIA on its website:
The rating agencies are now indicating that the ratings of the Insurance Company are dependent on other factors besides the amount of capital or claims-paying resources it has.
This has been the big excuse for MBIA not downstreaming the $900 million at issue to the insurance sub. They have asserted that no matter what they did, the ratings agencies will not give them an AAA. Moody’s has decided to correct the record. Again, another falsehood from MBIA, and a whopper at that. Felix Salmon, in a fresh post, tells of a conversation with a Hampton Finar of the New York State Insurance Department, and the NYSID falls largely in line with the MBIA story:
MBIA “needed a capital infusion to help them ride this out at triple-A,” said Finer: “they weren’t hitting the rating agency ratios”. This is almost exactly the same as the Jay Brown talking points. The capital-raising was done for the sake of the ratings agencies, and once the ratings agencies said that it wouldn’t do any good, there was no obvious point in doing so any more.
This is debatable; MBIA could conceivably have raised enough capital, although it would have been massively dilutive. But that still isn’t the same as saying it was unattainable, which is what Finer implies (in fairness, it would probably be seen as highly aggressive for a regulator to call the rating agency to verify the accuracy of the statements that MBIA made to NYSID, so it’s understandable that NYSID would share MBIA’s view. We hope they’ve wised up now).
The NYSID also seems more than a tad in denial about the viability of the bond insurer’s business prospects. Again from Salmon:
Was NYSID upset that MBIA didn’t send the money downstream? Not particularly. If it had really wanted MBIA to do that, it could have forced the issue, but it didn’t. “We have a lot of authority over how that money gets used,” said Finer. “We’d like to see what else can be done with it.” If that involves sending it to a different subsidiary, that might be fine; the only thing he seemed keen not to see was the money getting sent directly back to shareholders…..
Finer was also keen to see MBIA back in the business of writing insurance again. “We don’t really want companies in indefinite run-off, they’re kind of poisonous,” he said, since such companies have much less incentive to pay out than one which stands to lose a lot of business if it starts denying claims. “Companies should be downgraded, frankly, in indefinite runoff.”
What about a corporate structure where the old insurance subsidiary was in de facto runoff while a new subsidiary was writing new policies? That could be made to work, said Finer, so long as the reputation of the new subsidiary rested to some degree on the alacrity with which the old subsidiary paid its claims.
This conversation appears to have taken place before the Moody’s downgrades, and the severity of the cut on MBIA may put a different complexion on things. The NYSID may be regretting its decision to indulge MIBIA on keeping the $900 million at the parent level.
I must admit I have trouble with the logic here: things are OK at the MBIA insurance sub; we’d rather have them pursue new business. As we have discussed at length elsewhere, there does not appear for there to be any strategically viable route for them to take. Whether the insurers recognize it or not, the best economic scenario (as in maximum NPV) is for them to be in runoff mode.
Any attractive new business opportunities will be highly limited given their deteriorating outlook. The rating agencies are no doubt worried about other shoes dropping. While subprime writedowns have largely run their course, Alt-A and Option ARMs have only begun to hit in a serious way (although the monolines may not be seriously exposed here) and the housing-related deterioration in muni credits has just started. So as the Moody’s negative outlook indicates, things can only get worse. Yet to keep the company from shrinking, the pressure will be high to write more business than is attractive on a risk/return basis given the external environment and their competitive disadvantages.
And if they do go ahead and somehow write new business? Well, it allows management to preserve its holding company empire, and the nature of insurance is that you collect premiums and pay losses later. So they might be able to kick the can down the road for a few years more beyond what the endgame horizon would otherwise have been. But when the gig is finally up, it will be a larger book, and therefore a larger mess, that will need to be resolved.
Yet per Salmon, the regulator reaffirmed his confidence in the solvency of MIBA:
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.
The key variable in the statement above is “current”.
A question for you since this isn’t my field of expertise.
I understand the game that went on with the monolines and the muni bond business. It was basically a rigged game. But if the politicians are insisting that the same standards apply to corporate credits and government credits isn’t that putting the new companies like Berkshire’s insurance operations in jeopardy. As you mentioned in this post or one other, the credit quality of muni’s is deteriorating and at least to my mind, they are not as transparent as corporates particularly on the pension liability side. Could this be the worst time to get into this business with the politicians looking over your shoulder?
Like I said, not my strong suit so your comments or others would be welcome.
Buffett has just started his muni insurance business and his initial insurance operation did reinsurance, which is a tough game. They are very disciplined and write business only when the returns look favorable. So even in the muni bond guarantee business now means bona fide risk assumption. Berkshire would still be a good candidate to pursue it. However, if history is any guide, they’d be highly selective.
And yes (and I confess I had forgotten about the pension liability issue, that’s another biggie), this is NOT a good time to be making guarantees on muni credits. I’d trust Berkshire to be tough-minded enough; I’d be skeptical about anyone else.
Still have doubts about the ability of anyone to properly assess risk in this field given the opacity.
Hi Yves, I would like to know your opinion on mbia free cash situation. On their last 10q, it said if they are downgraded to A by moodys or sp, they would have about 8.4 billion in free collatorol left from the 16 billion. This is not including termination payments. If you assume they would have to pay as much termination payments as collatorol, that leaves about 2.4 billion. Even 8.4 billion is scarey enought. Isnt this garanteeing bankruptcy, since they have no ability to raise cash.
Buffet still has a very marginal role in the muni market; Berthshire Hathaway is mostly wrapping previously wrapped munis, and doing very little primary issuance. Buffet doesnt seem to be really scaling up his operations right now. His long term commitment to the industry is not very clear, as muni underwriting is profitable in the long run but does require to set up a large structure from the beginning (with a very small average deal size, smooth processing – in underwriting, risk management & back office – and economies of scale are essential). The muni market for monolines is likely to further shrink, and the last two AAA incumbents (Assured Guaranty and Financial Security Assurance) will probably keep their currentlarge market shares (we’re talking 50% for FSA right now for example), with Buffet at the margin. Both Assured and FSA were recently affirmed (hence attracting little media coverage) and seem to be now benefiting from their conservative culture. Other new players have confirmed their interest for the industry – notably Macquarie – but as with Buffet their long-term commitment is unclear (it’s an essential criteria in the ratings process).
On a side note Ackman publicly announced a couple of days ago he was going short on FSA in the CDS market. His bets against MBIA and Ambac gave him some credibility but this time he’s trying to catch a bigger fish since FSA is fully supported by Dexia (Belgian bank, possibly the largest public finance provider in the world). Will be interesting to see what comes next.