Doubt over opportunities for new monolines

With financial guarantors hit by a raft of downgrades in recent months as a result of exposures to subprime mortgage-linked securities – restricting their ability to generate new business - several new players are waiting in the wings to fill the void. But in the current market environment, is there enough business to justify their optimism?

In June, Australia’s Macquarie Group served notice of its intent to establish a New York bond insurance arm with an advertisement that ran in the New York Times. If the plan goes ahead, the subsidiary – to be called Municipal and Infrastructure Assurance – will focus on financial guarantees and credit insurance, with initial capital of $2.5 billion.

Although Macquarie declined to comment, it has reportedly held preliminary discussions with the New York State Insurance Department (NYSID) on filing an application for an insurance licence.

Meanwhile, New York-based private equity firm Ripplewood Holdings has been linked with a similar move, with reports suggesting it will establish a monoline insurance business with a capital base worth $1.5 billion.

Warren Buffett’s Berkshire Hathaway has already entered the financial guarantee business, receiving its licence in December 2007 from the NYSID. By the end of the first quarter this year, Berkshire Hathaway Assurance had underwritten an estimated $400 million of municipal bonds.

Given the turbulence that has afflicted the monoline sector this year, the speculation surrounding new entrants is hardly surprising, particularly since the two oldest and largest monolines – Ambac and MBIA – were respectively downgraded by Moody’s from Aaa to Aa3 and A2 in June.

With Financial Security Assurance and Assured Guaranty the last of the major bond insurers to maintain AAA ratings, there could be opportunities for other companies who have not had their reputations battered by the subprime debacle to earn healthy fee income from underwriting new issues.

“It is likely there will be new entrants as long as the market remains in turmoil and guarantors with reputations intact can get good pricing,” predicted Tamara Kravec, a New York-based insurance analyst at Bank of America Securities. “There is a lack of capacity that will encourage new players.

“In previous cycles it would usually take a new guarantor three to five years to build up the business, getting the ratings and track record to write muni business. In this cycle, however, we may see the process accelerate because of the lack of capacity and the demand for the service,” added Kravec.

Nevertheless, even those companies linked with joining the business have not made any firm plans as yet.

“So far we have only actually received one application from Berkshire Hathaway,” confirmed the NYSID in an email statement. “Others have indicated plans to file but have not yet filed, although we encourage and are supportive of new entrants.”

The message is similar from the Bermuda Monetary Authority (BMA). The British overseas territory of Bermuda, located in the North Atlantic, is home to a number of bond insurers, including Assured Guarantee.

“In principle there is still interest in the market regarding potential opportunities in the financial guarantee business given the capacity losses experienced within the industry,” said Matthew Elderfield, chief executive officer at the BMA. “However, whilst there was preliminary interest at the beginning of the year from an applications standpoint, this has not been reflected in broader follow-up activity in terms of firm business proposals.”

According to Elderfield, the situation is unlikely to change in the current environment. “The lack of applications is due to continuing market uncertainty and lack of ratings stability. It is hard to predict when market conditions will stabilise, although theoretically the opportunity for financial guarantee business remains,” he added.

Given that structured credit was – until the market collapsed – a particularly lucrative source of business for the monolines, the immediate focus of monoline insurers will remain on the municipal bond sector. But there are even questions over the value of third-party guarantees in this part of the business, which might act as an impediment to new players.

“Rating agencies are currently rethinking their ratings for municipalities, which could bring them more in line with corporates,” explains Kravec. “If the municipalities that were rated double-A get upgraded to triple-A, they are not going to structure their issuances with bond insurance. And if that transpires, that could shrink the market for guarantors, especially if the structured finance markets struggle to come back.”

See also: Ambac, MBIA finally get S&P downgrade, Moody's to follow suit
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