Saturday, February 23, 2008

Will Ambac have a deal next week?

(Naked Capitalism) We aren't in a position to answer the question posed in the headline, but following a leak that lead to a 250 point rally in the Dow, the noises coming from the team trying to rescue the troubled number two bond insurer have suddenly taken an optimistic tone. While the initial reports were vague, the Wall Street Journal, the Financial Times and the New York Times carry broadly similar reports.

Ambac and the rating agencies received a proposal from eight banks (Citigroup, UBS, Royal Bank of Scotland, Wachovia, Barclays. Societe Generale, BNP Paribas, and Dresdner) on Friday afternoon. As the Times reports, the proposal involves both providing an equity infusion and splitting the company:
Under Ambac’s plan, one part of the company would guarantee relatively safe municipal bonds, while the other would insure more complex securities backed by mortgages and other debt. In all, Ambac guarantees about $556.2 billion of securities.

The company also hopes to raise $2.5 billion through a rights offering to its existing shareholders; the sale will be backed by banks. Ambac also plans to raise roughly $500 million in new debt, according to the person who has seen the plan, who was not authorized to talk about it.

The banks, which include Citigroup and UBS, delivered a draft of the plan to Ambac and credit ratings agencies on Friday, and the company is expected to give its formal consent soon. Officials involved in drafting the plan hope the two new subsidiaries will both receive triple-A ratings, though the firm backing mortgage-related bonds could be rated slightly lower.

Note the artful phrasing: this is Ambac's plan, but the document came from the eight banks, as stated in the Wall Street Journal, "committing to the equity and debt participation."

Note: the banks aren't making an equity infusion. As I read this, they are merely backstopping a public offering by Ambac. This is the most lukewarm form of support they could provide.

Why haven't the banks stepped forth more wholeheartedly? Analyst James Bianco of Bianco Research, in an e-mail this evening, goes through the history and is mystified as to why a deal hasn't been wrapped up long ago:
The Monoline bailout hysteria started January 23.
The New York Times - (January 24) Next on the Worry List: Shaky Insurers of Bonds
Regulators fear a possible chain of events in which the troubled bond insurers, MBIA and Ambac, might be unable to keep their promise to pay investors if borrowers default on their debt.....the talks focused on raising as much as $15 billion for the companies … Eric R. Dinallo, the New York insurance superintendent who regulates MBIA..... suggested that the group move in as little as 48 hours to get a deal done ahead of any downgrading of the bond guarantors by credit ratings firms.

So the bailout was suppose to be done by Janaury 26 and total $15 billion. We have been told that a monoline downgrade is critical to the entire financial system. UBS estimates it will cost the banking system $203 billion in additional writedowns. Barclays estimates it will cost $143 billion in writedowns. Oppenheimer estimates that it will cost Merrill, Citi and UBS $40 to $70 billion alone.

Today we learn that a bailout is again very close.
The Financial Times - (February 22) Banks to aid Ambac with up to $3bn
A group of banks is preparing to inject $2bn to $3bn into the troubled bond insurer Ambac.... The money from banks would be part of a plan to split Ambac’s operations, people involved in the discussions said. Ambac is also considering raising equity from shareholders and it is not yet clear how much capital it will need, or what credit ratings the split businesses will have.

Let me get this straight.

If the monolines get downgraded, the banking system is at risk for $143 billion to $203 billion of losses. This is why they were 48 hours from a $15 billion deal on January 23. Now on February 22, they are again 48 hours away from a $3 billion deal for just Ambac spread among eight banks. So the longer they talked the smaller the number got.....

My questions - If the fate of the financial system only needs $3 billion to get “fixed,” why did it take eight banks a month to negotiate coughing up $300 million each? Don’t they pay Robert Rubin more each year? B of A took less much less time to bailout Countrywide with a $4 billion deal all by itself.

Something just doesn’t make sense here. If they are staring at hundred of hundreds of billion in losses, and $300 million each stops all this, why was their even a negotiation? Just write the check and move on to the next issue.

What am I missing?

I think Citi paid Rubin only $15.2 million, but point well taken.

Personally, I am surprised too that he banks are stepping up now as opposed to a month ago, since as we discussed earlier, the idea of a split makes it vastly less attractive for the banks to provide support. Any break-up plan is likely to be biased in favor of shoring up the muni operations. Dinallo's head would be on a pike if after all these machinations, a newly established muni operation didn't get a triple A rating. If the banks faced a free rider problem a month ago (which was presumably one reason not to stump up cash) when it was merely the structured finance businesses that appeared to be in trouble, that issue got magnified by now that the muni business is looking like the higher priority.

And FT Alphaville pointed out, as we have, that multiple businesses will require more equity than a single one:
So MBIA is paying lip service to the idea that they can’t favour one class of claimant over the other. But how they’ll do that remains unclear. For a start, as its chief executive hinted at above, two (or three or four) separate businesses will require greater capital underpinning than in one combined entity. And what has always been rather unclear in the bond insurer split plan is where the reserves go.

So reason 1. for not doing a deal may have been a free rider problem. To continue the list:

2. Writing a check may not make the problem go away. Remember, the worst outcome for the banks is not that the monolines are downgraded; it's that they throw scarce cash at the problem and the downgrade threat resurfaces in six months to a year. That means they have wasted money and will still face the damage inflicted by a downgrade, or face an ongoing sinkhole of having to put funds in every time the monolines look shaky.

3. Not all the banks may be that badly exposed. One thing that is nasty about these deals is that everyone at the table is assumed to stump up the same amount. Some may not regard their exposure as that bad. They have their numbers; the analysts don't. Remember, even though Citi and Merrll have large CDO positions, they also have taken large writeoffs. They may not think they have further downside. And one big name not participating, or demanding a lesser role, could poison the negotiating dynamic.

4. They may have believed the monolines' prior statements. Ambac and MBIA have both been maintaining that Bill Ackman is all wet, that his mark to market analysis is wrong. Apparently the CDS contracts the insurers wrote do not have to be paid out until the CDOs liquidate, and for some contracts, apparently, a liquidation does not trigger a payout on the principal portion of the deal; they aren't required to pay until the underling assets reach final maturity, which can take as long as 30 to 45 years. That means the payouts are spread out over a longer time period than Ackman assumed.

Note I'm not entirely sure I buy this argument, simply because the insurers have never been very forthcoming when pressed. If the bulk of their agreements worked this way, the downgrade worries should have gone away. The fact that they didn't suggests matters aren't quite that simple. Yet the S&P and Moody's downgrade threats would seem to make this moot. It doesn't matter who is right; what matters is what it takes to placate the ratings agencies.

5. The banks are in vastly worse shape than they dare admit. Maybe contributing $300 million is a big deal for them, and they have been pressing behind the scenes for a government bailout or (more likely) that official pressure be applied quietly to get the rating agencies to back down. Remember, as we said before, the rating agencies are the part of the equation that is the most malleable. Maybe the banks took a month to play that strategy out.

So I may very well be proven wrong and Ambac will be rescued and split up, which seemed a particularly implausible outcome. If the press has this right, the banks and Ambac are largely on the same page. The wild card in theory is the rating agencies, but in fact, they are desperate not to downgrade the monolines. They've moved back their deadline any time an excuse cropped up. So I'd expect them to fall in line unless there is something deficient in the plan, such as inadequate detail as to how the split will be put into effect. But that may lead to further negotiation rather than a flat-out rejection.

1 comment:

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