Bond Insurers Under Assault

Monoline bond insurers are enduring increasing pressure with a renewed assault Wednesday by activist investor Bill Ackman and looming downgrades of their vaunted triple-A credit ratings.

In a widely distributed 20-page treatise targeting monoline firms MBIA(MBI Quote) and Ambac Financial (ABK Quote), Ackman argues that losses at the bond insurers have been underestimated.

Ackman, the head of hedge fund Pershing Square Capital Management, estimates that losses at Ambac related to its exposure to residential mortgage-backed securities and asset-backed collateralized debt obligations will be about $11.6 billion and that losses at MBIA could be as much as $12.6 billion.

"MBIA and Ambac's exposure to nearly the entire universe of CDOs also compounds their exposure to many other classes of [residential mortgage-backed] securities with MBIA and Ambac being exposed to 3,131 and 4,179 unique tranches of ABS respectively," Ackman writes in his letter, which was sent to members of the financial media, in addition to the Securities and Exchange Commission and other industry participants. "These larger numbers of exposures will likely cause MBIA and Ambac to experience losses similar to that of the entire residential mortgage backed securities market."

Ackman has been railing against the integrity of bond insures for nearly a decade and has billions to gain should shares of Ambac and MBIA continue to fall in value. The activist is believed to have short positions in both financial guarantors, which have seen tremendous volatility in trading over the past week as rating agencies including Fitch Ratings, Moody's Investors Service and Standard & Poor's threatened to strip the firms of their coveted triple-A ratings. The pristine ratings are a necessity for bond insurers, who rely on them to backstop potential losses on debt including municipal bonds and structured debt.

Fitch on Wednesday downgraded little-known guarantor firm Financial Guaranty Insurance Co. from triple-A to double. Fitch also stripped Ambac of its triple-A rating last week and now rates the company double-A as well.

Ackman also argues that monolines, which are usually structured with a holding entity and an operating company, should be forced to stop funneling money up to their parent company.

An Ambac spokesman in New York declined to comment and a call to MBIA in Armonk, N.Y., was not immediately returned

Shares of MBIA closed down 12.6% and Ambac fell 16.1% in Wednesday trading, following Ackman's report.

Bailout Plan Complicated

The flap surrounding monolines has compelled the New York Insurance Superintendent Eric Dinallo to try and orchestrate a bailout of the sector by encouraging investment banks to provide some support capital that could either bolster the insurers or be used to form a reinsurance pool to assume some of the liabilities on their books. An accord among some of the challenged banks, such as Merrill Lynch(MER Quote) and Citigroup(C Quote), might be difficult to achieve, especially since those banks have suffered their own massive writedowns on subprime-related bets.

Earlier Wednesday, Oppenheimer & Co. analyst Meredith Whitney added more fodder to the writedown fire speculating that banks Merrill, Citi and UBS(UBS Quote) may see further writedowns linked to monoline bond insurers. She estimates that monoline-inspired writedowns may hit as much as $75 billion.

Ackman's letter places added pressure on the industry and may inspire a further notching down of the monoline sector if his estimates are to be believed. In addition to the letter, Ackman also called for an "open source" forum in which Wall Street participants could calculate their own view of losses using publicly available data.

Estimates tied to how much capital monolines will need has been wide-ranging. Sean Egan, principal at independent rating agency Egan-Jones, estimated last Friday that monolines may need as much as $200 billion to shore up their balance sheets in anticipation of mounting defaults on the mortgage paper that has come to comprise much of the debt in question by the monolines.

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