Ambac has already turned down the proposal. In a statement, the insurer said the offer would “result in little to no net capital relief to support Ambac’s ratings”, and that it “continues to vigorously pursue various alternatives to take our franchise forward to the benefit of all our policyholders”.
It is expected FGIC and MBIA will also reject Buffett’s offer, but the long-term future of the three monolines remains in doubt.
Recent credit market turmoil has eroded the capital positions – and claims-paying ability – of monolines most exposed to asset-backed securities linked to the troubled US subprime mortgage sector.
The situation has led to severe downward ratings pressure on monolines. Downgrades would not only affect the monolines, but also the securities they guarantee, sparking fears of another sell-off by investors and a fall in the value of wrapped bonds.
MBIA has clung on to its AAA rating after raising $3 billion in new capital since the start of 2008. Ambac and FGIC have been downgraded to AA by Fitch, with the latter getting the same treatment from S&P.
Buffett said the reinsurance package on offer would ensure the municipal bonds in question “would carry a real AAA insurance, and would sell in the market as if it had real AAA insurance, whereas now the bonds sell at significant discounts”.
In terms of the costs to monolines, Buffett added Berkshire Hathaway will take over the municipal bond liabilities of the monolines for a premium equal to one-and-a-half times the premium left over the remaining life of the bonds. Put simply, while the move would free up much-needed capital for the monolines, the offer would cost them more than the revenue generated by guaranteeing the bonds.
“When I go to St Peter, I will not present this as some act that should entitle me to get in,” commented Buffett, acknowledging the offer – valid for 30 days - was heavily in his company’s favour. “If they felt this premium was too high or they could do better, then they could take the other deal.”
Market reaction highlighted the continuing feeling of pessimism surrounding insurers. Five-year credit default swaps for MBIA and Ambac have widened from 369.2 basis points and 370bp on February 8 to 475bp and 442.9bp on February 12.
“There is much contagion and negative sentiment going on; so although it helps to a degree, the plan is far from an all-encompassing solution to the sector’s problems,” said Greg Peters, New York-based head of US credit strategy at Morgan Stanley. “But from a broader perspective, it at least suggests that, if these companies want to avoid a systemic disaster, this is on the table.”
Buffett’s plan, however, would essentially strip monolines of their best-performing assets, leaving them with only structured credit assets on their books.
“The monolines would be left with just the toxic assets in structured finance where their capital would be destroyed,” said boutique investment research firm Independent Strategy in a report. “The plan does not solve the problems of credit defaults in structured finance or the danger of counterparty failure if the monolines go belly up.”
Independent Strategy estimates monolines could end up with $65 billion to $70 billion in losses from the subprime fallout, much higher than their claims-paying resources of $49 billion.
Peters said Buffett could hardly be blamed for staying clear of non-municipal assets. “At the end of the day, structured credit losses are real, thus no-one is talking about rescuing that side of the business.”
One London-based credit analyst told Risk Buffett’s plan would weaken the monolines’ financial position. “It would leave them with reduced claims-paying ability, while lower diversification in their portfolios could actually increase the likelihood of downgrades,” he argued.
An alternative to Buffett’s plan would be a bank-led bailout. It has been rumoured that Ambac is in talks with an eight-bank consortium comprising Barclays Capital, BNP Paribas, Citi, Dresdner, Royal Bank of Scotland, Société Générale, Wachovia and UBS.
However, given the banking sector’s own capital constraints resulting from subprime exposures, there are serious doubts whether this option will come to fruition.
“The main question is whether other plans are a cheaper alternative to what Buffett is proposing, assuming the monolines have other plausible choices,” states Peters. “Nonetheless, this offer lessens the probability of a dealer-led bailout in my view.”
The week on Risk.net, July 7-13, 2018Receive this by email