Bond insurers: Between rock and a hard place
With a Wall Street bailout a long-shot, the tough times are likely to continue for troubled firms like MBIA and Ambac.
NEW YORK (CNNMoney.com) -- It's not easy being a bond insurer nowadays.
Capital-squeezed players in the industry like Ambac (ABK) and MBIA (MBI) are under siege by credit rating agencies, which have threatened to cut the insurers' sterling 'AAA' ratings. To make matters worse, Wall Street banks have reportedly balked at a proposed rescue plan for troubled players.
And with private equity investors now hesitant to step in, bond insurers face few survival options.
Bond insurers, or so-called monolines, have long occupied an obscure part of the financial services market, getting little attention for their core business of insuring corporate debt and municipal bonds issued by city and local governments to construct buildings and schools.
Nowadays they are making headlines because they also insured the mortgage-backed securities that collapsed as a result of the current credit crisis.
Capital squeeze. Insuring mortgage-backed securities proved disastrous when the insurers found they could not afford to cover all the claims filed by the troubled banks, which have endured billions of dollars in writedowns on toxic mortgage securities.
Those bets sunk the credit rating of ACA Financial Guaranty Corp. in December, and now threaten the rating of MBIA and Ambac, which stand to lose $3.5 billion and $2.25 billion, respectively, if they get downgraded, according to Standard & Poor's.
Calls to Ambac were not immediately returned. A spokesperson for MBIA said that the company was confident in its capital position and its underlying health.
Those fears prompted a reported meeting between a number of Wall Street banks and New York Insurance Superintendent Eric Dinallo who implored them to provide capital for these troubled insurers in an effort to prevent that from happening.
Big banks, which have a vested interest in keeping these companies afloat since it could mean further writedowns, however, are suffering through their own capital crisis.
"I don't think banks in any way, shape, form or fashion could really come to the rescue," said Nancy Bush, managing member at NAB Research in Aiken, S.C.
Major U.S. financial institutions like Citigroup (C, Fortune 500) and Merrill Lynch (MER, Fortune 500) have taken drastic steps lately in an effort to raise capital after writing down billions of dollars on the value of mortgage-backed securities.
Earlier this month, the two companies sold stakes to foreign, state-run investment funds in exchange for capital infusions. Citigroup went one step further by slashing its quarterly dividend, making it the latest in a series of banks to do so.
Moreover, there's no indication that a one-time capital infusion would rescue these troubled firms. If the housing market worsens, argues Donald Light, senior analyst at independent research and consulting firm Celent, these bond insurers could require more capital.
"The solution for now is not a solution for the next 24 months," said Light.
There has also been plenty of speculation that a private equity or a distressed opportunity investor could step in to rescue these troubled firms, including famed distressed opportunities investor Wilbur Ross, who was reportedly in takeover talks with Ambac representatives.
While a Ross deal could happen, others may have been inadvertently scuttled.
Speculation about the Wall Street bailout sent shares of both Ambac and MBIA soaring in Thursday trade, leaving interested investors to face a much bigger price tag, noted John Atkins, credit analyst IDEAglobal.
"The rub there is the equity price went up so much on the talk of bailout plan that makes it a little less appealing," he said.
One palatable remedy for bond insurers, is pushing off some of their risk to the reinsurers, which act as a backstop for these companies.
Last month, Ambac did just that, striking a deal with established player Assured Guaranty (AGO), which agreed to reinsure $29 billion of its policies, ultimately freeing up some capital for Ambac.
Similar deals could be struck with a handful of other reinsurers, but it's unlikely Ambac or MBIA would be able to find companies willing to insure the risky parts of their portfolio.
"No one wants to accept risk they can't quantify," said Mark Lane, analyst for William Blair & Co. LLC.
Dismal fate. So what's likely to happen to these troubled firms that ran what was once considered a safe business?
If firms like Ambac and MBIA are get hit with a downgrade and fail to find a life preserver from either Wall Street or an outside investor, they could initiate a run-off on their toxic securities portfolio, essentially refusing to write new policies and instead focusing on the bond insurance business they relied on for years before.
But competitors are already attempting to acquire some of that market share.
Last month, Warren Buffett's Berkshire Hathaway (BRKA, Fortune 500) announced plans to open a bond insurance business in New York State and is already attracting the attention of customers of Ambac and MBIA. And shares of Assured Guaranty gained in Friday trade after a JPMorgan Chase analyst bet that the company will boost its business in the coming month.