The rumors of potential rescues for imperiled bond insurers are flying fast and furious, as the capital markets fret over this once obscure sector now at the center of Wall Street's credit storm. There's the massive rescue plan led by New York Insurance Superintendent Eric Dinallo, an exceedingly complex and delicate undertaking that still seems a somewhat remote possibility. And there are news reports about the possibility billionaire investor Wilbur Ross may launch a takeover of Ambac Financial ( ABK), whose share price has been on a roller coaster amid crippling ratings downgrades and rumors. The outlook for insurers like Ambac and MBIA ( MBI), however, appears to be far from hopeful, and any potential rescue is fraught with challenges. A bank-led bailout, as Dinallo reportedly is pursing, would have to rely on institutions like Citigroup ( C) and Merrill Lynch ( MER) that have their own capital problems, having just written down billions due to poor mortgage-related bets. And a potential sale of the troubled guarantors, also known as monoline insurers, may be a challenging proposition even for potentially interested buyers like Ross or Warren Buffett, who could simply start their own firm or buy one in better shape. To be sure, understanding the underlying businesses of these companies is no small task -- particularly for investors such as Ross, known more for his investments in simpler companies such as steel, textiles and coal mining operations.
FGIC's Plight Illustrates Challenges
Take the case of closely-held, little-known financial guarantor Financial Insurance Guaranty Co. The firm, founded in 1983, has largely been left for dead by its most prominent investor, the Blackstone Group ( BX), which recently wrote down its investment in the guarantor. Run by CEO Frank Bivona, the firm is considered one of the big four financial guarantors, which also includes MBIA, Ambac and FSA. Blackstone announced plans to acquire a 23% stake in FGIC nearly five years ago from General Electric ( GE). Blackstone invested $700 million in the New York-based firm, along with private-equity shop Cypress Group, PMI Group ( PMI) and CIVC Partners. PMI maintains a 42% ownership stake in FGIC. Blackstone and Cypress each own a 23% share, while CIVC has a 7% stake with GE retaining a 5% position. Blackstone declined to comment for this article and the other firms did not return phone calls. Back at the time of the FGIC acquisition, GE was willing to part with a big stake in the financial guarantor because although it represented a steady income stream, return on the equity was fairly low considering its conservative business. Similar to many monoline insurers, FGIC focused on providing so-called insurance wraps on the staid securities of state and local municipalities. Those insurance wraps essentially provide credit enhancement for debt on risky towns and communities and make investors such as pensions and other insurance firms more comfortable about buying bonds without having to expend the effort of doing their own due diligence on each individual municipal deal. According to sources familiar with the firm, roughly 90% of FGIC's business in 2003 was derived from underwriting municipal deals, which have a low probability of default and where loss severities are minimal because, towns and cities can presumably raise taxes to service their obligations. FGIC's handlers, however, had different designs for monoline insurance and began encouraging it to juice its returns by broadening its underwriting scope. About a year after the Blackstone purchase, FGIC launched a strategy focusing on structured finance and began expanding more into the public finance markets, which offer relatively richer premiums. Those efforts comprised hiring some key executives, including veteran Goldman Sachs ( GS) healthcare banker Ellen Gordon. Gordon, hired in late March 2004, was charged with leading FGIC back into underwriting healthcare insurance -- a business line it had abandoned nearly 10 years prior. Around the same time, FGIC poached former MBIA executive Kenneth Degen to head up its venture into structured finance.