Andrew Clavell has a really good blog entry on the monolines today, even as MBIA somehow managed to sell $700 million in new equity in the public markets, over and above the $300 million it sold to Warburg Pincus. (Which is itself over and above the $500 million that Warburg Pincus has already invested and which at the moment is deep underwater.)
This looks like good news for MBIA: there’s appetite for its equity, at a price. But here’s the thing: that price is just $12.15 per share, which could well be significantly below the value of MBIA in run-off mode. If you think that MBIA will get downgraded and stop writing new insurance, but won’t go bankrupt, then the insurer could well be a screaming buy at these levels.
Bill Ackman, of course, is still short MBIA even at these depressed levels. He and his spreadsheet reckon that MBIA has a huge negative number in the equity column; as a result, he’s not only short the stock but he’s very long protection. What he’s waiting for is the stock to go to zero, MBIA to default on an obligation, and his credit-default swaps to pay out massively.
But after crunching Ackman’s spreadsheet, Clavell is a bit more sanguine:
The 700 tabs of gut-wrenchingly dull data funnel up to an estimation of CDO losses for Ambac and MBIA. Oddly enough, these aggregate losses seem unexceptional, particularly since they are expected to be incurred over the remaining life of the guarantees.
All the same, he quotes Pimco’s Bill Gross, in the FT, making an exceptionally good point:
How could Ambac, through the magic of its triple-A rating, with equity capital of less than $5bn, insure the debt of the state of California, the world’s sixth-largest economy? How could an investor in California’s municipal bonds be comforted by a company that during a potential liquidity crisis might find the capital markets closed to it, versus the nation’s largest state with its obvious ongoing taxing authority?
It does seem a bit silly, when put like that. Insurance companies are meant to be much bigger and much more solid than the credits they insure. Up until now, California has issued bonds which were wrapped (insured) by Ambac. The wrap garnered the bonds a triple-A rating, which allowed them to be held by investors who were forced by mandate to invest only in triple-A debt. That’s the key: the triple-A mandate is the important thing, rather than the actual creditworthiness of the bonds.
Pretty soon, anybody with such a mandate is likely to have to sell his wrapped bonds, since if the monolines get downgraded those bonds won’t have a triple-A rating any more. As Clavell notes, "Pimco must be rubbing their hands with glee": it’s a huge buy-side company which isn’t constrained by triple-A mandates and which loves nothing better than a fire sale of cheap debt.
Now this is a profit opportunity for Pimco, and it might result in losses for certain investors who thought they were investing in only the safest instruments. But there’s no tsunami here, the tsunami just kicks in when European banks holding AAA-rated instruments have to suddenly allocate a huge amount of capital against those bonds the day the rating gets downgraded.
Eventually, we’ll find ourselves in a world without a triple-A fetish, the world of the recent past where some investors felt they could outsource their credit-analysis duties to the ratings agencies. That too will be good for Pimco: I’d much rather have Bill Gross doing my credit analysis than Moody’s. And I’m sure that Pimco will have a wide range of capital-guaranteed products for people who want utmost safety.
When that happens, the demand for both ratings agencies and monolines will be much lower than it has been, and the world could cope with a monoline or two in run-off, especially if Berkshire Hathaway steps in to fill some of the gap. But the move from this world to that world might still be a bit unsettling for some.