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. 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.
FGIC's Plight Illustrates ChallengesTake 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.
Such moves saw the privately-held financial guarantor shift from underwriting some 90% in munis to about 70% presently, according to people familiar with the firm. The bulk of that new business underwritten by FGIC was vigorously vetted and framed by the common underwriting insurance mantra, "What is the likelihood of default?" But the subprime mortgage debacle that began to unfold in the early part of 2007 caught financials and firms such as FGIC and pitted rating agencies against monoline insurers, whose staffers ironically are either plucked from rival guaranty firms or are ex-rating agency employees themselves. FGIC, who many observers suspect will imminently receive a downgrade by one or more of the ratings agencies, learned that Fitch Ratings was placing the insurer on watch for a possible downgrade the day of its company holiday party in Manhattan Dec. 14, which tainted the event with an overriding sense of anxiety among its employees. Due to the trouble in the mortgage market, rating agencies began issuing a raft of warnings informing monoline insurers that they would need to significantly beef up their capital resources in order to pay claims should defaults rise in some of the more esoteric mortgage securities where the firms have provided backstop. In response to the Fitch potential downgrade, FGIC has said publicly that it is hammering out a plan to build up its capital base. But it has been more than a month since that announcement and, as with the other monolines, few are certain how much capital will be sufficient to appease the ratings firms. The result for monolines like FGIC is an eerie state of limbo in which attracting new business is all but impossible with so much uncertainty encircling the sector.
runoff . There are too many viable alternatives in front of us." On late Thursday, the British newspaper the Evening Standard reported that billionaire investor Ross may be in serious discussions to take over the bond insurer. Even in the face of the possibility that Wilbur Ross may come in and buy an Ambac or an FGIC -- another firm he may have looked at, sources tell TheStreet.com -- the outlook for the most rattled of the guarantors still appears to be fuzzy. A well-known vulture investor, Ross has said publicly, including during an interview with Bloomberg, that he's been looking at bond insurers. "Why would you want to write a contract if you don't know that the contract is worth anything?" notes senior insurance analyst Rob Haines at CreditSights. A Ross investment would provide some spark to Ambac, but investor jitters about the guarantor industry may still linger. Callen has been staunch in saying that the company is aiming to operate as a triple-A company, but triple-A or not, challenges will persist for the firm if it can't write any new business and its competitors are scooping up market share.
Damage Could Already Be DoneSpeaking generally about the monoline insurers, Fitch Managing Director Thomas Abruzzo says the damage done to their reputations might be the most difficult thing to repair. "Outside of the financial strength that's really the most important issue right now," the rating official noted. "The industry has lost is luster." Sean Egan, managing director at independent rating agency Egan-Jones, said Friday on CNBC bond insurers may need $200 billion to backstop losses and keep their triple-A ratings. On Tuesday's fourth-quarter earnings call, Ambac's acting CEO Michael Callen said that the company was not in runoff -- the process in which a guarantor collects payments on its existing book of business and writes no new insurance policies. "A word that has been banished from our halls here is 'runoff,'" Callen said Tuesday, in response to an analyst question about the company's performance. "No one here has given that any real consideration. We're not even seriously looking at
Calls to Ross in New York and emailed messages were not returned. Ross' Ambac bet essentially amounts to a view that the monoline chaos may be approaching a bottom or, in the case of Ambac, may be overblown. His view is that the future business of underwriting monolines will not be impaired once the time passes, especially since much of the guarantor's business, although sullied by esoteric debt, still is largely driven by municipal bond insurance and other more conservative plays. Some say that a deal for Ambac might be hurt by a recent $30 billion reinsurance deal that the firm struck with Assured Guaranty -- one of two financial guarantors seemingly in pristine shape. That reinsurance deal was completed as part of its bid to save its triple-A rating, but the result could mean that although protected from losses, Ambac may be losing some payment stream and hence mitigated revenue for vultures like Ross looking to make a distressed play for the guarantor. Ambac's agreement with Assured also promises more reinsurance for the much healthier guarantor over the next three years. That said, the devil is in the details of such agreements and those could not be learned.
Limited OptionsFor its part, FGIC is said to have written little to no new business over the past few months, according to people familiar with the firm. That's the case with pretty much all the monolines, save for firms like Assured. Internally, FGIC has siphoned some of its employees from various business units to manage its existing book of business and evaluate its options. FGIC also recently installed a turnaround and crisis specialist, John Dubel. The executive spent much of his time running his own turnaround firm and working at financial advisory firm AlixPartners. He has been hired to take on a new position of chief risk officer at FGIC, which combines the job functions of risk mitigation, portfolio risk management and credit risk, according to a FGIC spokesman. The spokesman added that FGIC wanted to streamline these functions. A call to the new executive, fielded by an assistant, was not returned. One bright spot so far at FGIC is that bonus compensation, which was revealed this week, has largely not been decimated as many employees had feared. But uncertainty still looms at the firm. While there have been no waves of layoffs, many are job hunting for fear there may be a shakeup, according to sources familiar with the situation. The irony is that many of the guarantors may find themselves at the rating agency shops that called them on the carpet. Meanwhile, existing MBIA and Ambac competitors, which have managed to escape the bad underwriting of its rivals, are benefiting in a big way -- including Assured. According to industry newsletter Bond Buyer, financial guarantor Financial Security Assurance Holdings has captured a 52% market share in the monoline space. FSA is owned by Brussels-based bank Dexia. Assured also has fared well for itself. Competition is also coming from Buffett, the so-called sage of Omaha, who via his Berkshire Hathaway ( BRKA) holding company has launched his own initiative in attempt to underwrite muni debt. In the end, Ross may launch his own guarantor outfit or use Ambac as a shell from which to operate, if he can tolerate the potential for losses in its portfolio.
In the face of a 75-basis-point emergency rate cut enacted by the Federal Reserve on Tuesday to 3.5%, from 4.25%, Ambac's Callen described the market conditions as "the best in 10 or 15 years." The reality is that firms like Ambac, FGIC and MBIA may not be able to benefit unless they can find a savior -- if not Ross, then someone else. CreditSight's Haines notes that Ambac, FGIC and MBIA, part of the big four bond insurance cadre, may never regain their once unchallenged position. "They are not going to end up being the dominant financial guarantors," Haines notes. "No one wants to do business with them."