Bond insurance

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See also AIG and commutations.

Bond insurance is a service whereby issuers of a bond can pay a premium to a third party, who will provide interest and capital repayments as specified in the bond in the event of the failure of the issuer to do so. The effect of this is to raise the rating of the bond to the rating of the insurer; accordingly, a bond insurer's credit rating must be almost perfect. The premium requested for insurance on a bond is a measure of the perceived risk of failure of the issuer.

Government bonds are almost never insured; municipal bond insurance was introduced in the US in 1971, and by 2002 over 40% of municipal bonds were insured, often by a procedure involving payment of a single premium at the purchase of the bond.



The first monoline insurer, Ambac Financial Group, was formed in 1971 as an insurer of municipal bonds. MBIA was formed in 1973. [1]

Taxable investors benefit from the exemption of municipal bond interest from Federal income tax. In many cases local bonds are also free of state and local taxes. Taxable investors face a compelling incentive to purchase local bonds. However, an investor holding a large portfolio allocation in local bonds carries a risk of substantial loss if the local economy becomes depressed, for instance if a local industry declines or a major natural disaster strikes, and defaults ensue. On the other hand, diversifying nationally causes loss of the tax benefit.

If a AAA-rated monoline insurer guarantees a municipal bond, the investor gains the benefit of owning a diversified portfolio and retains the local tax benefit. (The investor is even better off than owning a diversified national portfolio, which might suffer an occasional default: the insured bond can only default if the issuer defaults, and the insurer experiences defaults on its entire portfolio in excess of the insurer's capital).

When insuring taxable bonds, as opposed to municipals, bond insurance is a 'pure credit' business which does not take advantage of tax-induced market anomalies. The insurer seeks to insure credits with little likelihood of default, which the market will nevertheless pay a premium to insure, perhaps because of investor restrictions on the amount they can invest in non-AAA credits or other anomalies.

Until 1989, multiline insurance companies were permitted to guarantee municipal and other bonds, in addition to their other businesses such as property/casualty and life insurance.

As the number and size of insured bond issues grew, regulatory concern arose that bond defaults could adversely affect even a large multiline insurer's claims-paying ability. In 1975, New York City teetered on the edge of default during a steep recession[2]; in 1983 the Washington Public Power Supply System defaulted on $2b of revenue bonds from a troubled nuclear power project [3]

Under New York State's Article 69, passed in 1989[4] , multiline insurance companies are not permitted to engage in financial guaranty businesses (and vice versa). A cited rationale was to make the industry easier to regulate and ensure capital adequacy[5]

In recent years, much of the monolines' growth has come in structured products, such as asset backed bonds and collateralised debt obligations (CDOs), and the total outstanding amount of paper insured by monolines reached $3.3 trillion in 2006. [6] This contingent liability is backed by approximately $34 billion of equity capital[7]

Major bond insurers

The major bond insurers in the US include:

  • ACA Capital
  • Ambac Financial Group (Ambac)
  • Australian Guarantee Corporation (AGC)
  • CIFG
  • FGIC
  • Financial Security Assurance, Inc (FSA)
  • MBIA Insurance Corporation
  • XL Capital

Companies whose sole line of business is to provide bond insurance services to one industry are called monoline insurers.[8]

Market description

"... The nine U.S. companies whose business focuses on providing insurance against credit defaults together insure about $2-1/2 trillion of domestic and international securities. Historically, they focused on insuring the timely payment of principal and interest on U.S. municipal bonds. This remains a very important business line. Indeed, as of September 30, 2007, the guarantors insured about $1-1/2 trillion of such bonds, more than half of all U.S. municipal bonds outstanding. The vast majority of the underlying bonds were rated investment grade. However, insurance from AAA-rated guarantors raised the ratings of the insured bonds to AAA, which lowered interest costs to the issuers and made the bonds attractive to a wider range of investors.

In recent years the financial guarantors expanded rapidly into insuring asset-backed securities (ABS), especially collateralized debt obligations (CDOs). By September 30, 2007, they had guaranteed more than $1 trillion of ABS, including over $700 billion of U.S. ABS. The U.S. ABS included about $200 billion of U.S. residential mortgage-backed securities (RMBS) and securities backed by home-equity loans and about $125 billion of CDOs collateralized by ABS (CDOs of ABS) that contained U.S. subprime RMBS. In addition, they have guaranteed more than $300 billion of U.S. and international corporate CDOs.

In the case of CDOs, the guarantors typically used credit derivative contracts to insure the super senior tranches. That is, they insured securities that would suffer credit losses only if the losses on the underlying collateral were so severe that all other tranches, including some tranches rated AAA, were wiped out. The possibility of such severe credit losses was seen as remote, and these securities indeed have suffered little or no credit losses to date. However, in the case of CDOs collateralized by subprime RMBS that were originated between late 2005 and 2007, the possibility of loss is no longer seen as remote. In many cases, super senior tranches of such CDOs of ABS are trading at substantial discounts to par value. The growing possibility of credit losses on these securities has caused some of the guarantors to report financial losses and the rating agencies to require those guarantors to raise capital to maintain or regain their AAA ratings. Those guarantors reportedly are exploring various options for bolstering their financial strength, but it is not clear that all of them will succeed. Thus, it is well worth thinking through how further downgrades of some guarantors’ credit ratings might affect overall financial stability.

Channels Through Which Financial Stability Might Be Adversely Affected

Such downgrades might adversely affect financial stability through several channels. These include:

  1. the potential for disruptions to municipal bond markets,
  2. potential losses and liquidity pressures on banks and securities firms that have exposures to the guarantors, and
  3. the potential for further erosion of investor confidence in financial markets generally.

U.S. banks’ direct exposures to losses from downgrades of guarantors’ ratings appear to be moderate relative to the banks’ capital. Although some securities firms also have such exposures, I will leave assessment of the magnitude of those exposures to the witness from the Securities and Exchange Commission. Banks hold large amounts of municipal bonds in their investment portfolios, but the actual risk exposure is far smaller. As noted previously, the guarantors typically have insured only investment-grade municipal debt. Thus, the credit risk of the underlying securities is low, even without insurance. Likewise, as noted previously, some banks could be obligated to purchase at par tender option bonds and variable-rate demand obligations that have been downgraded as a result of problems at the financial guarantors. Banks may also feel compelled by reputational concerns to purchase ARS that they have marketed to investors, even though they have no legal obligation to do so. Here again, however, losses to the banks would be limited by the relatively strong credit quality of the underlying bonds.

Of greater concern is the potential for losses at banks that have hedged their holdings of super senior tranches of CDOs of ABS with credit protection purchased from the guarantors. These hedges lose value when the financial condition of the guarantors deteriorates. In fact, many banks already have written down the value of their hedges significantly to reflect the market view that some guarantors may not meet their obligations on the protection they sold to the banks. Thus, further downgrades of the guarantors may not necessarily require those banks to write down the value of their hedges significantly further. However, as long as the concerns about the ability of some guarantors to meet their obligations persist, any further declines in the value of the banks’ holdings of CDOs of ABS will not be fully offset by increases in the value of their hedges.

Even if banks’ losses from exposures to the guarantors are moderate relative to capital, banks could experience significant balance sheet and liquidity pressures if they take significant volumes of tender option bonds, variable-rate demand obligations, or ARS onto their balance sheets. The banks that have these exposures are currently well capitalized. However, if these banks take on significant-enough volumes of such securities, the resulting downward pressure on capital ratios might prompt some of them to raise additional capital or constrain somewhat the growth of their balance sheets to ensure that they remain well capitalized.

Efforts to constrain the growth of their balance sheets could be reflected in somewhat tighter credit standards and terms for a variety of bank borrowers, including households and businesses. Many banks already have tightened lending standards and terms, likely in part because of balance sheet pressures associated with recent turmoil in financial markets. Further tightening would add to the financial headwinds that the economy already is encountering.

In addition to the direct effects of stress at financial guarantors on the municipal bond markets and banks, stress at guarantors could have adverse indirect effects on investor confidence in the financial markets generally. Investors could demand higher risk premiums for holding financial assets, which would place downward pressure on asset prices. If the drop in confidence was sudden, asset markets could become less liquid and asset prices could become more volatile. These effects would increase market risks and counterparty credit risks to banks and other financial market participants, which could prompt a pullback from risk-taking. However, a sudden drop in confidence seems unlikely. Financial market participants seem well aware of the difficulties the guarantors are facing and of the potential for further ratings downgrades. Indeed, spreads on credit default swaps for several of the guarantors exceed 1,000 basis points, which suggests that the market already is expecting further bad news regarding those companies’ financial condition.

Federal Reserve’s Efforts to Monitor and Assess the Effects on Financial Stability

The Federal Reserve has been carefully monitoring and assessing the channels through which deterioration in the financial condition of the guarantors could adversely affect financial stability. As primary supervisor of state-chartered banks that are members of the Federal Reserve System and umbrella supervisor for bank holding companies, the Federal Reserve has collected and analyzed information on banking organizations’ exposures to the financial guarantors. In these efforts we have worked closely with the Office of the Comptroller of the Currency, which is the primary supervisor of national banks, including the largest U.S. banks. We have also shared information with the Securities and Exchange Commission, which is carefully monitoring and assessing the exposures of securities firms, especially the very large securities firms that it supervises on a consolidated basis.

We also have been monitoring closely developments in municipal securities markets and in the markets for RMBS and CDOs, from which the principal pressures on the guarantors have originated. More generally, we have been analyzing the underlying causes of the recent financial turmoil and contributing to efforts by the President’s Working Group on Financial Markets and the Group of Seven’s Financial Stability Forum to develop recommendations for addressing the weaknesses in markets and institutions that the financial turmoil has made evident.

Liquidity and downgrade risk

1. "Moody's Opinion:

Overall, we view CDS activity as not materially changing the liquidity risk within the industry, and see the efforts of financial guarantors to establish contractual standards for CDS execution that mimic the conventional financial guaranty policy as reflective of their strong commitment to risk mitigation. Failure to maintain this discipline would surely threaten our existing rating paradigm";

2. "Moody's Opinion:

Rated financial guarantors exhibit very sound risk management practices, limiting ALM mismatching to a degree consistent with their overall low-risk operating paradigm. nevertheless, we view these "non-core" business activities — because of their liquidity risk, market risk and operational risk — as inherently riskier than the core financial guaranty business";

3. "Moody's Opinion:

While financial guarantor-sponsored MTN and ABCP programs might appear to represent meaningful liquidity risk to those guarantors, Moody's believes that actual liquidity risk is quite modest, due to the various protections built into the structures of those programs";

4. "Moody's Opinion:

Although these financial intermediation activities present an overall risk profile that is higher than the traditional financial guaranty business, the amount of liquidity risk they represent is manageable, and in fact tightly managed, in Moody's view";

5. "Moody's Opinion:

The inability of a claimholder to demand acceleration of payments is the most significant liquidity safeguard afforded the guarantors. It is an essential element that supports the business model and is supportive of the extremely high ratings of firms in this sector.

Rocky road for bond insurers as munis default

Forewarned bankruptcies linked to infrastructure projects from Las Vegas to Harrisburg, Pennsylvania, may prove Warren Buffett’s conclusion that insuring municipal bonds is a “dangerous business.”

Ambac Financial Group Inc., the second biggest bond insurer, faces as much as $1.2 billion in claims if a judge in Nevada allows Las Vegas Monorail Co., which runs a train connecting the city’s casinos, to reorganize in Chapter 11 bankruptcy. The City Council of Pennsylvania’s state capital shelved a plan to sell taxpayer-owned assets to meet payments on $288 million of debt used for an incinerator funded in part with bonds insured by a unit of Bermuda-based Assured Guaranty Ltd. Harrisburg is weighing a possible bankruptcy filing.

With state tax collections last year through September showing the biggest drop since at least 1963, as measured by the Nelson A. Rockefeller Institute of Government in Albany, New York, local governments are seeking concessions from creditors of public projects, including bond insurers. The moves further threaten companies backing $1.16 trillion of public debt that already face $11.6 billion of claims on collapsed securities backed by mortgages.

“It is a worst-case scenario if the dynamics of the municipal bond market change,” said Rob Haines, an analyst who covers the bond insurance business at CreditSights Inc., an independent research firm in New York. “The companies have modeled in virtually no losses.”

Ambac, MBIA Inc. and Assured Guaranty, the three largest bond insurers, have set aside 0.04 percent of the total public finance debt they insure, or $520 million, to pay claims on municipal securities, according to regulatory filings by the companies. Local governments are struggling with depressed property values and sales, 9.7 percent unemployment and a slowdown in consumer spending that has cut tax revenue.

Last year, 183 tax-exempt issuers defaulted on $6.35 billion of securities, according to Miami Lakes, Florida-based Distressed Debt Securities Newsletter. That’s up from 2008, when 162 municipal borrowers failed to meet obligations on $8.15 billion of debt. In 2007, 31 of them defaulted on $348 million of bonds.

“In the past, things had a way of getting worked out,” said Jim Ryan, an insurance analyst with Morningstar Inc. in Chicago. “States might have stepped up and helped out, but bottom line is that the states are in trouble.”

Insurers’ obit could be premature

"As 2009 draws to a close, the outlook for the municipal bond insurance market is looking uncertain.

Insured bonds reached a peak of 57.1% of new issuance in 2005, but as most insurers were downgraded after they unsuccessfully ventured into the hazardous territory of structured finance, that number dwindled to just 8.7% this month, according to Thomson Reuters.

However, the one company still writing new insurance believes the market is far from dead. Assured Guaranty Ltd. — parent of Assured Guaranty Corp. and Assured Guaranty Municipal Corp., formerly Financial Security Assurance — believes the insured portion of new issuance will more than triple in the next five years to eventually become a third of the issuance pie.

They are not alone. Other companies are working to enter the market, vowing to stay within the confines of public finance and reiterating the mantra that they will insure only investment-grade debt.

One example is Municipal and Infrastructure Assurance Corp., an insurance neophyte backed by Macquarie Group and Citadel Investment Group. MIAC has recently received financial strength ratings but has not released the information to the public yet, according to vice chairman Richard Kolman. He said the company plans to enter the market in the first quarter of 2010, backed by capital “multiples above” statutory requirements.

Other possible entrants are former players in the game tired of sitting on the bench.

MBIA Inc. — which saw its portfolio implode and company stock tumble by more than 94% from January 2007 owing to its backing of mortgage-related structured finance bonds — has created a public finance-only entity, National Public Finance Guarantee Corp., with hopes to begin writing new policies “sometime in 2010,” according to spokesman Kevin Brown.

Ambac Assurance Corp., which currently is at risk of having its stock delisted by the New York Stock Exchange, also attempted to reenter the market with a new public finance subsidiary earlier this year, but it was unable to raise enough capital for the restructuring. More recently, the company warned that it may have to file for bankruptcy protection as liquidity could dry up by mid-2011. Ambac declined to comment for this article.

Financial Guaranty Insurance Co., once the fourth-most active bond insurer, was suspended by New York state regulators in late November from paying claims until it repaired its tattered balance sheet. The company, which did not return calls for comment, has until Jan. 5 to submit a “surplus restoration plan.” Meantime, most of their public finance business has been reinsured by NPFG.

For all potential players, the lure of the market is clear. To start with, the risk is relatively small. Moody’s Investors Service data from 1970 to 2006 show the historical default rate of investment-grade municipal bonds — rated Baa or higher — was just 0.07% over a 10-year horizon, compared with 2.09% for corporate debt. Secondly, insurance can be a triple-win situation for all parties in the transaction. The insurer earns a premium for wrapping the credit, the lender gains the security of timely payments, and the borrower saves money by entering the market at a lower yield.

And it shouldn’t be forgotten that none of the fallen insurers left the market because of events within the public finance market. It was tasting the toxic flavors of structured finance that fatally compromised them.

Still, a number of analysts have doubts that the market for municipal bond insurance can be revived. After all, the low default rates that attract insurers are also a reason why borrowers can skip out on insurance altogether..."

Bond insurance problems in 2007

No monoline insurer had ever been downgraded or defaulted prior to 2007 [9]

In 2007, amid a housing market decline, defaults soared to record levels on subprime mortgages and innovative adjustable rate mortgages, such as interest-only, option-ARM, stated-income, and NINA loans (No Income No Asset) which had been issued in anticipation of continued rises in house prices. Monoline insurers posted losses as insured structured products backed by residential mortgages appeared headed for default.

On November 7, ACA, the only single-A rated insurer, reported a $1B loss, wiping out equity and resulting in negative net worth [10]

On November 19, ACA noted in a 10-Q, that, if downgraded below A-, collateral would have to be posted to comply with standard insurance agreements, and that 'Based on current fair values, we would not have the ability to post such collateral.' [11]

On December 13, ACA's stock was delisted from the NYSE due to low market price and negative net worth, but ACA retained its A rating [12]

Finally, on 12/19, it was downgraded to CCC by S&P[13]

The following month, on January 18, 2008, Ambac Financial Group's rating was reduced from AAA to AA by Fitch Ratings.[14]

Due to the very nature of monoline insurance the downgrade of a major monoline triggered a simultaneous downgrade of bonds from over 100,000 municipalities and institutions totalling more than $500 billion.

Credit rating agencies placed the other monoline insurers under review [15] Credit default swap markets quoted rates for default protection more typical for less than investment grade credits. [16]

Structured credit issuance ceased, and many municipal bond issuers spurned bond insurance, as the market was no longer willing to pay the traditional premium for monoline-backed paper[17]

By January 2008, many municipal and institutional bonds were trading at prices as if they were uninsured, effectively discounting monoline insurance completely. The slow reaction of the ratings agencies in formalising this situation echoed their slow downgrading of sub-prime mortgage debt a year earlier.

Mark to market and bond insurers

"...As if all that weren’t enough, we also find that people are confused about the fact that our insured credit derivatives are called “credit default swaps,” even though they have relatively little in common with the commonly held and traded instrument with the same name. Our swaps have most of the terms and conditions, and liquidity characteristics of insurance policies.3 We do not have to collateralize them, and they cannot be accelerated, unless we elect to do so as part of a remediation strategy.

Some of the big banks have been taking huge mark to market losses on portfolios of collateralized debt obligations (which is just a specialized form of securitization), or “CDOs.”

Many of the deals that we have insured through credit default swaps are CDOs, and those swaps have also had large mark to market losses. A frequently asked question is “how come it seems that the banks are taking such big losses, as a percentage of their positions, and yours are relatively small?” For the record, the amount of mark to market loss in our portfolio in Q4 2007 was about 2% of the amount insured, while for Merrill Lynch and Citigroup the amounts were over 25%.

So, why are they different?

  • They are marking securities they own outright, while we are marking insurance policies on similar securities, which provide for subordination and prevent acceleration. An insurance policy on a security should therefore have a different mark than the security itself because of these features. Even when a bank is marking an identical security to one that we’ve wrapped, the liquidity advantage of the insurance policy should result in very different estimates of fair value.
  • If they own the senior security we’ve guaranteed, the marks on the guarantee and their corresponding position largely offset each other, so the net mark that we see reflects only the change in value of the subordinate piece of the deal.
  • Many of the securities they’re valuing were NOT guaranteed by MBIA, so it’s unclear what relevance that part of their marks has.
  • Many of these institutions were originators of CDOs, and may be holding on balance sheet the portions of those deals that were hardest to sell, which also may be more volatile. The banks have had very significant non-cash, mark to market losses in the past two quarters, on positions that most analysts expect will recover a good bit of the value lost quickly once liquidity returns to the securities market. Unfortunately, these mark to market losses affect the banks’ regulatory capital position, since their regulatory model is based on fair value accounting. As a result, we’ve seen them sell big equity positions to new investors, including sovereign wealth funds. They are raising cash to cover paper losses. Many analysts expect that as the values come back in line, the banks will find themselves with huge amounts of excess capital, that may be

distributed to shareholders in the form of share repurchases. The practical effect of mark to market accounting then, may be to cause them to sell equity when prices are low and buy it back when prices are high.

Fortunately, the regulatory and rating agency evaluation of the bond insurers is NOT based on mark to market accounting. US statutory accounting, on which the capital evaluations are based, takes into account credit losses and impairments, but not fluctuations in fair value. It makes sense since the insurers have no option to realize, or risk of realizing, the current fair value. The mark to market serves only to confuse those who are not fully knowledgeable about the bond insurance business model.

Unfortunately, this is all too large a population. So comparing MBIA to the banks isn’t all that fruitful. A more relevant comparison might be to a company with similar exposures to ours, like AMBAC. They also have a portfolio of unconditional irrevocable guarantees which are not subject to acceleration, uncollateralized instruments and don’t trade. The marks relative to the exposure are also much smaller than those of Merrill and Citigroup in Q4 2007.

Insurer ordered to halt claims payments

"According to the investor relations section of the website of FGIC, the bond insurer part-owned by PMI Group and Blackstone:

'FGIC provides irrevocable and unconditional guaranty of timely payment of principal and interest on the securities it insures.'

As of Tuesday night, that claim no longer rang true.

Late on Tuesday, the long-suffering rival of MBIA and Ambac, disclosed that it had been ordered by New York’s insurance regulator to suspend all claims payments because of its violation of the state’s minimum capital requirements.

According to FGIC’s statement on the matter (emphasis ours):

On November 20, 2009, FGIC filed with the NYID its Quarterly Statement for the period ending September 30, 2009, in which FGIC reported a surplus to policyholders deficit at September 30, 2009 of $865,834,577 and an impairment of its required minimum surplus to policyholders of $932,234,577. The Superintendent of Insurance (the “Superintendent”) has directed FGIC to submit a plan to eliminate such impairment of FGIC’s surplus to policyholders.

The regulator has also banned FGIC from writing any new policies, though this will probably not have a major effect on a company which has had its ratings withdrawn by Moody’s, Standard & Poor’s and Fitch (though not before being quite comprehensively downgraded by each). FGIC has not insured a deal since January 2008.

The regulatory intervention is likely to result in a credit event for credit default swaps written against the bond insurer, although final determination thereof rests with the ISDA committee that decides such things. If that committee determines that a credit event has occurred, however, there could be a spot of bother in the credit markets.

Moreover, according to a Fitch report from 2008:

In the event that some form of regulatory intervention were to occur, FGIC’s exposure to credit derivatives (CDS) would be subject to immediate termination with its outstanding counterparties. In this scenario, FGIC would be required to settle the CDS contracts at their current market value; a level that Fitch believes is considerably greater than the company’s existing claims-paying resources.

For “exposure to credit derivatives” in the Fitch statement, read “contracts with a host of US and European banks”. There is, therefore, a very real risk that any banks that have not comprehensively written down their exposure to FGIC may be obliged to take some unpleasant hits.

How unpleasant? Here’s CreditSights, emphasis FT Alphaville’s: There will be only minimal recoveries in the case of a CIFG or FGIC failure. With a case specific to the monolines, all counterparties should consider that their liquidation does not adhere to federal bankruptcy code and creditors cannot take control of assets through “cram down” procedures. Recoveries will be pennies on the dollar and will not be realized for at least a decade. That’s right, 10 years. That is what the NY regulators have told us on numerous occasions. If a seizure is required, they plan to shut the books for the next decade before making any distributions so as to avoid a first-come, first-served scenario.

Almost all CDS written by the guarantors include solvency provisions. This is the so-called ‘nuclear’ event. If the regulators actually take control of a monoline due to the breach of minimum surplus levels, all of the credit protection that the particular company wrote in the form of CDS could be terminated at current market valuations, putting buyers of CDS protection with monolines as a counterparty in the queue with other claimants in a runoff portfolio. Under this scenario, obligations would increase exponentially and claims-paying resources would become woefully insufficient to meet these obligations.

But RBS analyst Tom Jenkins had a less apocalyptic view on Wednesday, emphasis FT Alphaville’s:

FGIC announced last night that it is to cease all claims paying with immediate effect and this will trigger CDS, as we saw with Syncora. In the interim FGIC is to undergo a restructuring - plan to be delivered to the NY Insurance regulator by 5th Jan 2010 with a return to compliance by Mar 25th, and if it doesn’t then it will liquidate. In the interim, as noted, with SCA a cessation of claims payment triggered CDS last May and that settled at 15c (don’t think there was a sub contract). Thinking to the impact on banks, well we sadly don’t know which banks have exposures to which monoline but all in I would expect FGIC exposures to be relatively small/manageable. The more interesting dynamic is that SCA used the plan which FGIC is adopting as a way to undermine the banks, and buyback RMBS at a huge discount (kind of a one-way commutation) and bring themselves back to life (well, sort of).

The only prior CDS event on a bond insurer involved Syncora, formerly known as XL Capital Assurance, which was itself an operating subsidiary of Security Capital Assurance (SCA). The Syncora event was triggered by a similar order from New York’s insurance regulator to cease payments and restore its capital surplus. In Syncora’s case, CDS protection sellers ended up having to cough up about $8.5m for every $10m they insured.

According to DTCC data, at the time of the credit event the net notional CDS outstanding on Syncora was about $1bn, so it is likely these payouts amounted to about $850m.

FGIC’s financial woes have been well trailed - in April, the company’s auditor warned there was “substantial doubt” about the insurer’s ability to continue as a going concern.

The insurer also has significant exposure — about $1.2bn — to Jefferson County in Alabama. Jefferson County was burnt by an interest rate swap deal with JP Morgan, and has been teetering on the edge of what would be the biggest municipal bankruptcy since California’s Orange County in 1994.Of course, some of Jefferson County’s financial woes were actually attributable to its decision to have its sewer revenue warrants insured by FGIC. When doubts emerged about the bond insurer’s creditworthiness, the county had to endure skyrocketing interest payments on its FGIC-backed auction rate securities. Whew.Still, FGIC is making a good show of having a plan:

FGIC is currently formulating a comprehensive restructuring plan contemplating FGIC’s commencement of a tender offer for the acquisition or exchange of certain residential mortgage backed securities (”RMBS”) guaranteed by FGIC in the primary market; FGIC’s continued pursuit of commutations with the holders of FGIC-insured collateralized debt obligations of asset-backed securities (”ABS CDOs”); and the commutation, termination or restructuring of FGIC’s exposure in respect of certain other obligations for which it has established statutory loss reserves; all with a view to remediate its RMBS, ABS CDO and other exposures, remove its capital impairment and return it to compliance with the applicable minimum surplus to policyholders requirement (the “Surplus Restoration Plan”).

What that means, in non-monoline speak, is that the insurer is hoping to get counterparties to contracts written on CDOs and other structured products to agree to cancel that protection. It is also seeking to buy back some of the RBMS it has insured from investors.|

FGIC must submit a “detailed and final plan” showing how it would improve its capital position to the New York insurance regulator by January 5 2010; failing that, the bond insurer may be forcibly rehabilitated or liquidated, with the latter the more likely outcome.

Elsewhere in the troubled world of bond insurers, Ambac announced its chief financial officer would resign from the post “to pursue other interests.” We hope those interests are in an industry with something resembling a future.

Dinallo: No Apologies For MBIA Split

New York's former insurance industry regulator, who may make a run for statewide office next year, defended one of his most controversial regulatory decisions Thursday.

In February, Eric Dinallo, then New York's Insurance Superintendent, allowed bond insurer MBIA Inc. (MBI) to split its municipal bond insurance business from its troubled structured finance business. The move triggered lawsuits against the company, the New York Insurance Department and Dinallo himself in his regulatory capacity.

In evaluating his approval of MBIA's split, Dinallo said Thursday, "The test is what we knew at the time," not how the plan plays out in the longer term. He made the comments after a lunch-time speech at an insurance conference in New York sponsored by Keefe, Bruyette & Woods Inc.

Dinallo resigned as the Empire State's top insurance regulator in July; a month later he formed a campaign committee to run for state attorney general should the current AG, Andrew Cuomo, not run for re-election and instead run for governor.

Dinallo approved MBIA's petition in February. Within months, 18 banks with exposure to MBIA through its structured finance business filed a lawsuit over the split.

The issue was $5 billion in capital that MBIA diverted to the municipal bond business in the split. The banks argued the money should be available to cover potential losses in their structured finance holdings.

The 18 financial institutions, which include Barclays PLC (BCS), Bank of America Corp. (BAC) and JPMorgan Chase & Co. (JPM), said the insurance department had no right to approve the move, which they said benefitted some policyholders at the expense of others.

The banks are asking a New York State Court to void that approval.

Dinallo said Thursday that in the event a troubled insurance company is seized, "all policies are not created equal" under the law."

MBIA suing Countrywide for fraud

MBIA Insurance can proceed with a lawsuit alleging Bank of America Corp.’s Countrywide Financial committed fraud in obtaining insurance on billions of dollars of mortgage-backed securities, a judge ruled.

The insurer, based in Armonk, New York, claimed in its suit that Countrywide “falsely represented” to MBIA, and to investors in trusts holding the securities, that Countrywide originated the mortgage loans in strict compliance with its underwriting standards and guidelines. The insurer has covered more than $459 million of losses as a result, MBIA said in the 2008 complaint.

New York State Supreme Court Justice Eileen Bransten, in Manhattan, denied Bank of America and Countrywide’s renewed motion to dismiss the bond insurer’s fraud claim. In the April 27 ruling made public today, Bransten also refused to dismiss a claim of successor and vicarious liability against Bank of America, which acquired Countrywide in 2009.

Bransten dismissed a claim by MBIA of “negligent misrepresentation,” against Countrywide, ruling the plaintiff had failed to show the commercial relationship existed between the two that would support the allegation.

Credit Suisse sued by MBIA over MBS

"- A Credit Suisse Group AG unit was accused in a lawsuit by MBIA Insurance Corp. of making fraudulent misrepresentations about mortgage-backed securities, causing the insurer to pay more than $296 million in claims.

The complaint against Credit Suisse Securities (USA) LLC, filed yesterday in New York State Supreme Court in Manhattan, also names as defendants two other units of the bank, DLJ Mortgage Capital Inc. and Select Portfolio Servicing Inc.

Credit Suisse made “pervasive and material misrepresentations” about a mortgage-backed securities transaction that was sponsored, marketed and serviced by the Credit Suisse units and insured by MBIA, according to the complaint.

The transaction, involving thousands of residential mortgages in a pool later transferred to a trust formed to issue securities that were to be paid down based on the cash flow from the loans, closed in April 2007, said Armonk, New York-based MBIA Insurance, a unit of MBIA Inc.

“CS Securities fraudulently induced MBIA to participate in the transaction,” MBIA said in the complaint. MBIA said the bank claimed it had “used certain strict underwriting guidelines to select the loans sold into the transaction when in fact it did not.”

Bruce Corwin, a Credit Suisse spokesman, declined to comment.

‘Institutional Pedigree’

Credit Suisse Securities pointed to its “strong institutional pedigree” while addressing the novelty of the transaction and touted its “due diligence” on the loans, MBIA said. The insurer also said that, at the time, Credit Suisse was the second-largest commercial bank and “viewed as a pioneer in the development of the residential mortgage-backed securities market.”

Since the transaction closed, the securitized loans have defaulted “at a remarkable rate,” MBIA said.

“Through Oct. 31, 2009, loans representing more than 51 percent of the original loan balance, or approximately $464 million, have defaulted and been charged-off, requiring MBIA to make over $296 million in claim payments,” MBIA said.

MBIA said that a review of the defects of the loans included in the transaction show they were “systematically originated with virtually no regard for the borrowers’ ability or willingness to repay their obligations.”

The case is MBIA Insurance Corp. v. Credit Suisse Securities (USA) LLC, 603751/2009, New York State Supreme Court (Manhattan).


Ambac files for bankruptcy

Ambac Financial Group Inc., a holding company for the bond insurer being restructured by state regulators in Wisconsin, filed for bankruptcy protection to reschedule payments on more than $1 billion in bonds and other claims.

The petition for Chapter 11 protection filed in Manhattan today listed assets of $394.5 million and liabilities of $1.68 billion. The Vanguard Group Inc. was listed as the largest shareholder, with 5.46 percent of the company’s stock.

The case is In re Ambac Financial Group Inc., 10-15973, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Ambac misses interest payment

From a just released 8-K:

On October 29, 2010, the Board of Directors of Ambac Financial Group, Inc. (the “Company”) decided not to make a regularly scheduled interest payment on the Company’s 7.50% Debentures due May 1, 2023 (the “2023 Notes”). The interest payment was scheduled to be made on November 1, 2010. If the interest is not paid within 30 days of the scheduled interest payment date, an event of default will occur under the indenture for the 2023 Notes. The occurrence of an event of default would permit the holders of the 2023 Notes to accelerate the maturity of the notes. As of June 30, 2010, the Company had total indebtedness of $1,622 million. The next scheduled payment of interest on the Company’s indebtedness is November 15, 2010.

To date, the Company has been unable to raise additional capital as an alternative to seeking bankruptcy protection. As such, the Company is currently pursuing with an ad hoc committee of senior debt holders a restructuring of its outstanding debt through a prepackaged bankruptcy proceeding. There can be no assurance that any definitive agreement will be reached. If the Company is unable to reach agreement on a prepackaged bankruptcy in the near term, it intends to file for bankruptcy under Chapter 11 of the United States Bankruptcy Code prior to the end of the year. Such filing may be with or without agreement with major creditor groups concerning a plan of reorganization. The filing for bankruptcy protection would accelerate the maturity of all of the Company’s indebtedness.

Ambac guaranteed debt is valued at 20 cents in swaps auction

Credit derivatives traders settling contracts that protected against a default by Ambac Financial Group Inc.’s bond-insurance unit set a value of 20 cents on the dollar for distressed debt backed by the insurer.

The price, the result of an auction by 14 dealers including Barclays Plc and Citigroup Inc., means sellers of swaps on Ambac Assurance Corp. will pay 80 cents on the dollar to buyers of protection to settle the contracts, according to data posted on a website from auction administrators Markit Group Ltd. and Creditex Group Inc.

Credit-swaps traders are settling contracts protecting more than $2.3 billion, according to Depository Trust & Clearing Corp. data, after Wisconsin regulators in March seized Ambac Assurance guarantees tied to subprime mortgages in an effort to restructure the insurer. That caused a so-called bankruptcy credit event, a committee of dealers and investors ruled in March, triggering payouts on the contracts.

Banks and other investors typically bought credit swaps on Ambac to protect against the risk it would be unable to make good on the guarantees they purchased from the insurer. Clients who purchased protection on residential mortgage-backed securities from Ambac lost a court bid last month to stop the Wisconsin regulator from winding down the insurer.

Distressed Debt

Dealers settled on a list of 156 bonds and loans guaranteed by Ambac that are eligible to be bought and sold in the auction today. They include home loan-backed notes sold by shuttered subprime lender Ownit Mortage Solutions that were once rated AAA by Standard & Poor’s and are now ranked CC, the second-lowest rating above default.

The debt includes bonds sold by Las Vegas Monorail Co., the elevated train line that filed for bankruptcy protection from creditors in January, according to the list published on the International Swaps and Derivatives Association’s website.

Also being auctioned are advances made to a $500 million film-securitization facility created in 2006 by cinematographer brothers Bob and Harvey Weinstein to fund their Weinstein Co. In March, Moody’s Investors Service cut the Weinstein Portfolio Funding Co. to Caa2, its fourth-lowest ranking, because of “continued weakness in the home video sector” and because of the declining credit rating on Ambac, guarantor of the loans.

The final price for the debt fell from an initial value of 27.5 cents on the dollar earlier today after the first round of the auction. Dealers had reported net demand to sell $300 million of the debt and matched that with orders from the banks and their clients, according to the auction website.

Regulators order Ambac Assurance to ’segregate’ assets

Ambac’s shares tumbled more than 20 per cent in mid-morning trade in New York on Thursday, after its regulator moved to take over some of the bond insurer’s more troubled assets – some $35bn worth.

Regulators in Wisconsin, where Ambac Assurance is domiciled, ordered the bond insurer to ’segregate’ those assets that have already generated significant losses, or are likely to.

In a statement, Ambac said it did not think the hiving off of those assets constituted an event of default, and that it had “reached a non-binding agreement on the terms of a proposed settlement agreement with several counterparties to commute substantially all of its remaining collateralized debt obligations of asset-backed securities”.

(What this means is that Ambac has agreed to pay policyholders a fee upfront in exchange for the counterparty agreeing to tear up the contract)

The regulator also received court approval to “impose a temporary moratorium on further claim payments to Segregated Account policyholders pending approval of a plan of rehabilitation”, according to a statement. The regulator has so far skipped payments worth about $120m.

That action is likely to trigger payouts on credit default swaps written against Ambac, as happened with both Syncora and FGIC.

The bond insurer also managed to persuade “counterparties to credit default swaps insured by [Ambac Assuarance] representing a significant portion of the net notional amount outstanding as of December 31, 2009…to temporarily forebear from accelerating the obligations of [Ambac Assurance] under such credit default swaps or asserting any claims against [Ambac Assurance] or any affiliate of [Ambac Assurance]based upon the segregated account rehabilitation proceedings.”

In effect, they’ve bought themselves some time to work something out.

But there’s another, scarier scenario. One described by CreditSights back in December as a “nuclear event” (emphasis ours):

a failure of this restructuring process and a continued violation of the OCI’s minimum capital requirement could result in a regulatory seizure of Ambac. This would set off the so-called “nuclear event”; which entails a number of adverse consequences including an event of default for $1.6 billion of Ambac’s holding company debt and the termination of CDS insured by Ambac Assurance which could liquidate mark-to-market claims in respect of underlying exposures in the amount of $23.1 billion.

Based on our conversations with the [New York Insurance Department], it is possible that the regulators could close the books for a number of years to see how claims shake out before making partial prorata payments and then closing the books again and letting all the policies run out before a final payment is made. Additionally, certain components of claims paying resources, such as installment premiums, would essentially be worthless under receivership. In all, this would equate to a recovery of pennies on the dollar

Even things don’t quite come to that, buried at the bottom of Ambac’s statement on the move by the Wisconsin regulator was the following paragraph:

Ambac may consider, among other things, a negotiated restructuring of its debt through a prepackaged bankruptcy proceeding or may seek bankruptcy protection without agreement concerning a plan of reorganization with major creditor groups

Ambac had first warned of bankruptcy risk back in November.

Ambac regulator files rehab plan

Wisconsin's insurance regulator on Friday filed a rehabilitation plan for Ambac Financial Group Inc.'s (ABK) bond insurance unit, seeking to ensure that claims on some $50 billion in policies are "compensated fairly."

Ambac Assurance Corp., the operating subsidiary of Ambac Financial Group (ABK), wrote insurance guaranteeing payment on billions of municipal bonds, as well as billions of bonds backed by mortgages. It faces lawsuits by mutual funds and hedge funds as well as policyholders, who are all battling to have their claims paid after the company ran aground during the financial crisis. In turn, Ambac and other struggling bond insurers have sued banks that packaged the troubled residential mortgage-backed securities they guaranteed.

Investors opposed to the rehabilitation plan say it unfairly compensates some claimants to the detriment of others. The state insurance commissioner, however, said it slows claim payments and makes the unwinding of that part of Ambac's business more orderly.

The rehabilitation targets 700 policies, with $50 billion outstanding, which were segregated by Wisconsin regulators in the spring. Ambac got into trouble in 2008 and 2009 with skyrocketing claims on policies it underwrote to insure mortgage securities that collapsed in value.

At one point, Ambac was paying out $150 million in claims a month, depleting its capital. In an interview Friday, Sean Dilweg, the Wisconsin insurance commissioner, said, "we were trying to rein in a company that we felt was in an involuntary run-off." The segregated account "shows a unique regulatory approach," he said. "It minimizes the collateral damage."

The state commissioner's plan, subject to confirmation by a Wisconsin judge, would allow claimholders of those segregated policies to receive 25% of their claims in cash and 75% in the form of 10-year notes with a 5.1% coupon. The idea is to preserve enough cash so the company can continue to pay claims. The commissioner said in a statement the cash payout percentage may increase in the future, subject to a yearly review of Ambac's condition.

Ambac unit to advise on troubled mortgage investments

"When life hands you lemons, make lemonade.

Bond insurers, including Ambac Financial Group Inc. (ABK), have been doing just that by forcing mortgage originators to make good on soured loans in insured securities. Ambac is taking it one step further, setting up a lemonade stand of sorts that will sell its securities advisory expertise to regulators and other investors.

The Ambac unit is RangeMark Financial Services Inc., a consulting group with around two dozen employees that it put together in July after acquiring an asset management and advisory firm.

RangeMark will allow Ambac "to better predict, manage, and mitigate the risks that we face," said David W. Wallis, Ambac's president and chief executive, in August.

Bond insurers and ratings agencies got into trouble by underestimating losses on mortgage-backed securities, particularly those backed by second mortgages. The problem of highly rated securities that turned out to be junk triggered a broader re-examination of credit ratings and loss assumptions on structured debt backed by mortgages and other assets.

In an interview Thursday, Robert Smith, RangeMark's chief executive, called the unit a "new school organization" that will provide advisory services and independent credit rating advice for structured credit products, not only for bond insurers but for other capital markets participants. He said he could not discuss revenue projections, and an Ambac spokesman said it was still in the early stages of development as a revenue producer.

According to a recent Moody's Investors Service report, bond insurers have estimated that they will receive more than $4 billion in remediation recoveries for breaches of contractual representations in transactions they insure, particularly on securitizations backed by second-mortgages originated in 2004-2007.

Smith said investors are also looking for advice on other asset categories. One job for RangeMark is to help Ambac examine these and other securities to help determine how they will perform over the long term.

"Having a company with experience looking at third-party portfolios and providing unbiased evaluations may help Ambac," said Thomas Adams, an attorney at Paykin Krieg & Adams LLP who works as a strategic consultant and expert witness on issues relating to the financial crisis. He previously worked at bond insurers Ambac and Financial Guaranty Insurance Co. or FGIC. "It might give them leverage and legitimacy when negotiating with Ambac's counterparties. Since the successful negotiation of commutations will be critical to whether, or in what form, Ambac survives, this might give them an edge."

In November, Ambac negotiated commutations, or cancellation, of four credit default swap contracts that covered its exposure to four collateralized debt obligations of asset-backed securities with multiple counterparties that were valued at $5.03 billion. Ambac settled the contracts for cash payments of approximately $520 million, less than the impairment Ambac had calculated on the exposure.

RangeMark could potentially help Ambac with more deals, Adams said. "A fresh set of experienced eyes might help spot things they might not have recognized."

Closest rival MBIA Inc. (MBI) has also been working on commutation talks, but could be hampered by its litigation with its investment bank counterparties.

Ambac shares traded down 5.3% recently, to 84 cents.


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