Ambac, MBIA Might Be `Buys' for the Few, the Brave: Joe Mysak
Commentary by Joe Mysak
Dec. 26 (Bloomberg) -- Buy the bond insurers.
That's a distinctly contrarian view, sure, especially after the year the bond insurers have had. Their fairly recent forays into subprime mortgages have put them in danger of losing their AAA ratings, which is what their business is based upon.
Yet if you look past the headlines, and the accompanying hysteria, maybe things are about to look up. The stocks of Ambac Financial Group Inc. and MBIA Inc., which both lost about 70 percent of their value the past three months, are showing up on some securities firms' lists of buy recommendations.
I wouldn't be putting my retirement nest egg into Ambac and MBIA stock, and if the last few years have taught us anything, it's that we shouldn't listen to the buy recommendations of Wall Street analysts or trust the companies that sell ratings. But at some point, someone is going to figure that the stocks are at least worth a speculation.
We know what's happened to the bond insurers. Most of it seemed to have taken place in the past fortnight, as the rating companies, with whom the future of the insurers is inextricably linked, announced the results of their reassessments of the guarantors.
Moody's Investors Service said it might downgrade FGIC Corp., and changed its outlook on MBIA to negative. Standard & Poor's Corp. cut the rating on ACA Financial Guaranty Corp. to CCC from A, lowered its outlooks on Ambac and MBIA, and was reviewing FGIC for a possible downgrade. Fitch Ratings said that Ambac, MBIA and FGIC all needed to raise more capital.
Money for Sale
That's it? The rating companies have given the financial guarantors a big, fat holiday gift, in the form of more time, and that's the most precious gift of all.
So that's the past. What's ahead for the financial guarantors? What's next?
They need to raise capital to avoid losing their AAA ratings. Make that billions of dollars, not tens of billions. And you know what? You can get anything for a price, and money is no exception, so I suspect that the insurers will get what they need. Current management may be sent packing, and staffs may be cut, but that's the price of survival.
The amazing thing about these insurers is that they could, if need be, close down, and still remain viable, going concerns. That is, they could stop doing new business, and because of the annuitant nature of their earnings, still make money.
All About Time
When it comes to the bond insurers, it's all about time.
The insurers are paid a premium upfront, but they only recognize earnings over time, as the bonds they insure mature. Think about it this way: Say the insurer is paid a $100 premium to insure some bonds for 10 years. The insurer has to put the premium aside, and earns only $10 a year.
The exception is if the issuer decides, let's say in three years, to refinance the bonds. Then the insurer can take the big gulp and the remaining $70. This is very simplified, but that's the model.
Remember, too, that the insurers make the regularly scheduled debt-service payments on bonds that default. They don't accelerate payment. If your 10-year bond goes into default, you don't get 100 percent of your money back right away. You get what you are owed over the next 10 years, while the insurer pursues remedies to the default.
They Love It
Is the bond insurance business going to go away?
I don't think so. The new management may decide that certain very profitable lines of business just aren't worth the trouble, but it doesn't look as if municipal bond issuers, underwriters or investors are willing to give up on the product.
Issuers like insurance because it lowers their borrowing costs -- or is supposed to. Whether it actually has in recent weeks, I have my doubts. Investors like insurance because it brings them peace of mind. Underwriters like insurance because it makes municipal bonds, which are particular and specific to a remarkable degree, into a commodity, and so easier to sell.
I kept looking for signs that this would change, but even in the midst of a barrage of bad news, almost half of the number of issues were being insured, and not only by FSA, the only guarantor not tainted by the subprime mess, but also by the ones that were most implicated: Ambac, MBIA and FGIC. The dollar volume that was insured declined a bit, but the number of issues, which usually runs around 50 percent, remained about the same.
It looks like one of the big stories of 2008 may be the survival of the bond insurers.
(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: Joe Mysak in New York atLast Updated: December 26, 2007 00:24 EST
Wednesday, December 26, 2007
Voltron says: If you believe this argument, I have a bridge to sell you.