Monday, February 4, 2008

Banks to MBIA: You're on your own

Bank losses from monolines likely $5-7 bln: analyst

Mon Feb 4, 2008 1:33pm EST

NEW YORK (Reuters) - Financial institutions are likely to take only around $5 billion to $7 billion in losses from their exposure to bond insurers, while a bailout of the industry by banks is unlikely, Morgan Stanley said on Monday.

Monoline bond insurers are under review to lose the "AAA" ratings vital to their business, as their capital is not viewed by rating agencies as adequate due to losses they are expected to take from insuring risky residential mortgages.

Some analysts have said they believe U.S. financial institutions exposed to the bond insurers are facing as much as $50 billion to $70 billion in losses, though Greg Peters, Morgan Stanley's lead credit analyst, said he views exposures as significantly lower.
"That (number) seems too high to us to begin with and that is a gross number," he said on Monday on a conference call.

Morgan Stanley evaluated mortgage exposure in Collateralized Debt Obligations (CDOs) insured by the bond insurance arms of Ambac Financial Group Inc (ABK.N: Quote, Profile, Research), FGIC, Security Capital Assurance (SCA.N: Quote, Profile, Research), and MBIA Inc (MBI.N: Quote, Profile, Research), and determined that exposures by U.S. banks is likely in the $20 billion to $25 billion range.

Once the capacity of the bond insurers to pay out claims is taken into account, and assuming that a bankruptcy doesn't force the insurance arms of the companies out of business, likely losses are in the $5 billion to $7 billion range, Peters said.

Bond insurers typically have holding companies, which issue stock and debt, while the insurance arm generates the income that pays dividends on the stock.
"These are very complex structures...very little in the way of investors really understand the dynamics of these structures," Peters said.

While the inability of an insurer to generate new business could weigh on the holding company, and potentially drive the stock price down to zero, the insurance arms could continue to operate on its existing business, and continue to pay claims, he said.
In this scenario, the counterparty exposure of banks to the insurers is negligible, he added.


Meanwhile Morgan Stanley continues to view a downgrade of MBIA or Ambac as likely, in spite of talks between banks and the New York insurance regulator for a bailout of the industry.
"We believe there will be downgrades, absolutely," Peters said. "A LTCM style kind of bailout is pretty remote."

Hedge fund Long Term Capital Management (LTCM) was bailed out by a consortium of banks in 1998 after it faced margin calls on heavily levered exposures to U.S. government bonds and emerging market debt.

"We just don't think the incentives exist, banks are clearly capital constrained, the exposure to the monolines is far from uniform, so one dealer might not want to help out their competitor when they have a very limited exposure," Peters said.

"I think the key difference is, unlike LTCM, these losses are not temporary," he said. "They're real losses, the ABS CDO losses are real and will actually be taken at some point in time, unlike the temporary kind of liquidity phenomenon of're actually asking banks and dealers to pony up cash to help plug a loss that's far from temporary."

Meanwhile, Financial Security Assurance (FSA), Assured Guaranty Corp (AGO), whose "AAA" ratings are not under review, and the new market entrant created by Warren Buffett's Berkshire Hathaway Inc (BRKa.N: Quote, Profile, Research) (BRKb.N: Quote, Profile, Research), will likely be sufficient to satisfy market needs for bond insurance, Peters added.

"You don't need to have an Ambac still in business, you've got the FSA, AGO and Berkshire Hathaway...they can come in and write new business," Peters said. "So we're not convinced that you need to have existing monolines still up and running as you have other ways that you could actually wrap that risk."

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