Thursday, February 7, 2008

The Wall Street Journal

February 7, 2008

Rescue Plans Won't Prevent Downgrades

February 7, 2008; Page C1

Rescue plans are starting to take shape for struggling bond insurers, but they aren't likely to prevent further ratings downgrades for many of the companies.

At least one such company isn't waiting around. In an effort to raise capital, MBIA Inc. yesterday said it would issue $750 million of common stock, a bigger offering than the $500 million issue it had initially planned.

The company also said it will revise its fourth-quarter loss of $2.3 billion, cutting it by $65 million. MBIA also added $100 million to its loss reserve, bringing the total special addition to $200 million.

Still, some banks and investors working toward salvaging the bond insurers, which guarantee the interest and principal in the event of default, are realizing that even the best plans could require them to settle for less -- less risk, less reward and bond insurers with less-than-triple-A ratings in the future, according to several people familiar with the rescue talks.

A group of banks -- betting that the insurers still have some value -- are working with the management and investors of New York-based Financial Guaranty Insurance Co. on a potential plan for FGIC. They have held a series of meetings and conference calls in recent days. The group, which is led by Calyon, a unit of French bank Credit Agricole SA, includes UBS AG, Société Générale SA, Citigroup Inc., and Barclays PLC. A Calyon spokeswoman declined to comment.

The banks are trying to figure out how to commute, or unwind, their credit-default swaps, which are contracts they entered into with FGIC and other bond insurers to guarantee their portfolios of complex debt securities known as collateralized-debt obligations, or CDOs, according to people familiar with the talks.

A consortium of banks working toward a rescue plan for bond-insurer Ambac Financial Group Inc. also is discussing a similar option, according to people familiar with the matter.

In exchange for unwinding the contracts, FGIC and Ambac could give the banks stakes in their companies through warrants, according to these people.

The banks, then, would share in the proceeds that the bond insurers would make as they collect premiums and wait for their existing portfolio of policies to expire, or "run off." In this scenario, the most the banks are hoping for is that the bond insurers' credit ratings don't fall below double-A, but they aren't getting their hopes up for a return to triple-A glory, according to two of the people.

"There's run-off value as you get rid of the toxic elements of these companies through commutations," says David Havens, an analyst at UBS Securities, who isn't involved in any of the bailout talks. "Only about 5% of the business is problematic, and 95% is fine."

Ambac, FGIC and rivals MBIA, Security Capital Assurance Ltd. and CIFG Holding Ltd. are exposed to about $100 billion in CDOs that were backed by rapidly deteriorating subprime mortgage collateral, according to Fitch Ratings.

Some analysts estimate that sharp downgrades of these bond insurers, or their insolvency, could cause banks to write down as much as $70 billion. In late December, for example, Calyon said €1.2 billion ($1.75 billion) in its write-downs was tied to bond insurers, mainly ACA Financial Guaranty Corp., which was downgraded to triple-C from single-A.

By unwinding the credit-default swaps, the banks would enable the bond insurers to free up capital, which they could use to help preserve their ratings or help prevent further downgrades.

Of about $315 billion in debt that FGIC had insured through to Sept. 30, 2007, about $31 billion was backed by mortgage collateral and $8 billion was backed by subprime mortgages, according to an FGIC presentation. Ambac has about $67 billion in CDO exposure. Spokesmen for FGIC didn't respond to calls to comment, and a spokesman for Ambac declined to comment.

Most of the bond insurers in the industry are under threat of losing their high-level ratings as the mortgage crisis increases the likelihood that they will have to pay out claims with limited access to capital.

Fitch, for example, says it is possible that the majority of bond insurers won't continue to have triple-A ratings in the future.

"It's just an indeterminable amount of losses on these assets and the final number could be far more significant that we had been envisioning," Thomas Abruzzo, managing director at Fitch, says. Last month, Fitch and Standard & Poor's downgraded FGIC to double-A from triple-A. Fitch also downgraded Ambac to double-A.

A key hurdle for the banks and the bond insurers is determining how much the banks should get in exchange for tearing up their credit-default swaps, and whether owning stakes in companies that could get further downgraded is fair compensation, says one person familiar with the discussions.

Another option being bandied about by analysts and others is to form a new company, funded by the banks, which could take responsibility for meeting the obligations of some of the insurance policies -- mainly the credit-default contracts -- weighing on the bond insurers.

This model would have the added benefit of enabling banks to unwind some of their credit-default swaps with the other beleaguered bond insurers, and guarantee their debt with the new, triple-A-rated bond insurer.

But there are potential downsides, too. Banks might be choosy about which risks they would be willing to let the new insurer take on, and that could mean bond insurers might be left with the high-risk business, Steve Stelmach, an analyst at Friedman, Billings, Ramsey & Co. noted in a recent research note.

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