Bond Insurers Under Assault

A new, blistering critique by activist Bill Ackman and a downgrade to FGIC added to the sector's woes.
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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


(MBI) - Get Report


Ambac Financial


, 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




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, 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


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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.

Time seems to be running short for monolines, even in light of a bailout package being coordinated by Dinallo. Sources tell

that the New York-led bailout initiative may be favoring a company-by-company rescue, since the monolines are not all equally stressed. Such a plan, however, might still take a considerable amount of time to arrange, sources say.

A call to Dinallo's office was not immediately returned.

Billionaire investors Wilbur Ross and Warren Buffett have both been pegged as possible saviors for the industry. But both savvy investors appear more likely to serve as rivals to the insurers by creating new outlets to insure debt. Moreover, recent rate cuts by the

Federal Reserve

, which slashed rates by 50 basis points to 3% on Wednesday, is creating an attractive environment for monolines, whose primary business is providing insurance on municipal debt.

A call for comment from Ross and Buffett were not immediately returned.

The U.K.'s

Evening Standard

last week reported that Ross was in serious discussions with Ambac about a buyout, but so far nothing has materialized. The information Ackman distributed Wednesday, while it may serve the activist's own interest, may also give Ross reason to pause about providing any fresh capital to distressed guarantors.

'As Good Dead As Alive'

Private equity firm Warburg Pincus late last year provided about $1 billion in funds for MBIA. The Armonk, N.Y.-based insurer issued 14% yielding notes that have fallen in value to about 70 cents on the dollar, but Warburg remains committed to the its MBIA investment, according to people familiar with the situation. Warburg on Wednesday sent MBIA an initial $500 million installment as a part of its agreement. The private equity shop will support an additional $500 million rights offering that also is expected to be shopped soon. Warburg speculates that there is still a tremendous amount of interest to own debt in bond insurers.

A person familiar with Warburg Pincus's thinking referred to Ackman's recent report as a misleading interpretation of the guarantor's position. "The implication that if you're not triple-A, you're bankrupt is idiotic," says the person.

The executive says Warburg's long-term investments in MBIA suggests that the private equity firm, while certainly hoping that big guarantor can emerge from the turmoil, realizes its MBIA investment is just as good dead as it is alive. The company can be profitable in runoff, the process in which it collects payments on its existing portfolio and underwrites no new policies, the source says.

A Warburg spokesman declined to comment.