The talks follow the release on January 22 of a proposed rescue plan by the New York State Insurance Department (NYSID) to improve the capital positions of monolines, protect policyholders and ensure the continued availability of bond insurance.
Since December, several monolines – including Ambac, MBIA, CIFG, FGIC and SCA Capital – have come under severe pressure to avoid ratings downgrades, culminating in Ambac losing its triple-A rating from Fitch on January 18.
Fears that this action could trigger a further wave of downgrades - and heavy losses to dealers and investors exposed to monolines - prompted several calls for a co-ordinated market response to the problem. And, although some observers might think the talks held this week came too late, the market reacted as if a bailout for the affected insurers is imminent.
Five-year credit default swaps for Ambac and MBIA, both north of 700 basis points on Monday, were respectively trading at 455bp and 400bp on Thursday, reflecting a degree of restored confidence in the sector.
Precise details on the talks, specifically how the monolines can boost capital and avert ratings, have not emerged – NYSID declined to talk to Risk yesterday – but various analysts viewed a bailout as the only available solution.
“The costs for a bailout compared with the consequences of not doing anything are very favourable for the government and regulators,” said Jochen Felsenheimer, head of credit strategy and structured credit research at Unicredit. “Ultimately this is not the final solution – it is more a case of fighting the symptoms. So it will not help limit any impact on the real economy but it helps to restore confidence in credit derivatives and the structured credit market.”
Alexander Batchvarov, head of international structured finance research at Merrill Lynch, argued guarantors should be supported in their hour of need in return for the support they have given the financial markets over several years. Even so, he said stabilizing the financial position would not by itself restore investor confidence.
“The main concern investors still have is the possibility of another firesale of assets, which will widen spreads further and erode the value of their investments,” said Batchvarov. “Only when the market believes the threat of firesales has diminished will we start seeing a restoration of investor appetite and, beyond that, new issuance.”
One ominous dimension of NYSID’s proposal was its intention to develop stronger regulation for bond insurance. “Since it is clearly time to develop new rules for the road, the department is drafting new regulations that would redefine the future activities of bond insurers,” stated NYSID in a press release.
As to whether this means insurers will be encouraged to avoid risky structured credit products, Batchvarov believes all players active in the market will be risk averse in the short term.
“This will show itself through a dramatic repricing of risk and the unwinding of excess leverage seen in recent years. But I would imagine, going forward, risks surrounding mark-to-market losses and liquidity issues will be factored more vigorously into the monolines’ underwriting standards,” concluded Batchvarov.