We’ve been saying that the legal basis for splitting up the bond guarantors and preferring one group of policyholders (municipalities) over everyone else seems pretty dubious and therefore is likely to trigger litigation.
Analysts at Bank of America agree. From Bloomberg:
Regulators’ plans to break up bond insurers into “good” businesses covering municipal debt and “bad” businesses liable to subprime-related losses may trigger “years of litigation,” Bank of America Corp. analysts said.
New York Insurance Department Superintendent Eric Dinallo and New York Governor Eliot Spitzer said last week that insurers may need to be divided if they can’t raise enough capital to compensate for losses on subprime-mortgage guarantees. FGIC Corp., the fourth-largest of the so-called monoline insurers, asked to be split on Feb. 15 after Moody’s Investors Service cut the Stamford, Connecticut-based company’s top Aaa ranking.
“Despite the regulatory interest in separating the exposures, the essential fact remains that all policy holders, whether municipal or structured finance, entered into contracts backed by the entire entity,” analysts led by Jeffrey Rosenberg in New York wrote in a note to investors dated Feb. 15. A breakup is “likely to lead to significant legal challenges holding up the resolution of the monoline issues for years.”…..
“The fact that one group of policy holders’ exposures has imperiled the policies of the other does not mean they should forfeit the value of their claims altogether,” the Bank of America analysts said.
Investors in credit-default swaps based on the bond insurers may also seek damages to compensate for losses, according to the research note.
Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.
The cost of credit-default swaps on Armonk, New York-based MBIA Inc., the world’s largest bond insurer, has soared to $1.7 million upfront and $500,000 a year to protect $10 million of bonds from default for five years, according to CMA Datavision. Ambac credit-default swaps were at the same level as MBIA at the close of trading in New York on Feb. 15. The contracts, which cost $25,000 a year ago, trade upfront when investors see a risk of imminent default.
Any breakup of the companies may cause “significant widening” in the credit-default swaps as the structured finance company is likely to be “deeply distressed,” the Bank of America report said.
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Companies break up all the time (Daimler-Chrysler, and soon Altria, etc.), and somehow they manage to divide up the assets and liabilities. Companies in difficulty get restructured all the time, and competing claims of different groups of creditors or stakeholders get considered and resolved somehow. What’s special here?
Sure, there might be years of litigation. But that’s only because in America, everything under the sun is subject to years of litigation.
Gee that’s kind of a bit, um, NON ROBUST.
When companies split up and transfer an asset away, puhleeze believe me their creditors kind of have a REAL SAY in whether that transfer was for value or not and if not then voiding it as a fraudulent transfer.
There is something called the Uniform Fraudulent Transfers Act.
You don’t just get to do what you want.
Although, in New York, the law is that insurance companies are not fiduciaries of their insureds.
There is a very big difference here. In the breakup or liquidation of a normal business, you have a very clear priority among claimants (the IRS first, earned but unpaid employee wages next, and then the debtholders have very clear, contractually specified rights, ie, whether they are secured or not, how subordinated they are).
With an insurance operation, the big liabilities are the the policy liabilities and the unearned premiums. Those are both for the benefit of the policyholders.
Note that any debt is at the holding company level, and I believe all or nearly all the employees are also in the holding company. So anything due to them is subordinate to the obligation of the subsidiary to the policyholders.
There is NO legal basis for preferring on set of policy holder over another if it isn’t specified in the policies (and per BofA, it appears not to be). You can’t as an insurer arbitrarily say, “gee, you are a young person, you will live longer, so I’ll pay your claim but not that of the old person.” Under the law, discriminating in favor of the municipalities is regarded as every bit as arbitrary.
This isn’t merely “this will be litigated for years.” That is actually being polite. This is “the courts will probably overturn this.”
And remember, these insurers are not at risk of imminent financial failure, so the regulators can’t argue they were forced to act; indeed they have all maintained they CAN pay their claims, but don’t have enough of an equity cushion to keep a triple A. But the breakup will put enough equity (they call it reserves in insurance-speak) to get the munis an AAA; that will disadvantage the remaining policy holders.
I can’t believe they went down this path without thinking this through. If it can occur to me, it should have occurred to them. But a reader pointed out that he saw an interview of Dinallo on Bloomberg. The reporter asked about what the plan meant for the non-muni policyholders, and it was clear Dinallo hadn’t given it any consideration.
bAnalysts at Bank of America
After everything that has happened in the credit markets, we are still listening to these lemmings?
Ever heard of, “talking their book”? What do we expect them to say? Should B of A be thrilled that much of the toxic horseshite’ on it’s books will be marked to market which will vaporize even more worthless junk on it’s books?
Aren’t we past the Ruby Slipper scenario?
If CDO and CDS are not insurance policies (withing the context of the monoline insurance companies) then things look very different (regarding breaking up). They are just another asset or liability to be dealt with.
in reading the ny statute, it does appear there is a strong argument that any contract guaranteeing payment in the event of a credit event, when executed by an insurer, is a financial guarantee and thus an insurance policy. its not entirely clear, but ill assume it is so.
the best i could think they would get away with would be to say, look, the premium coverage ratio on the muni side is 200% (these guys have bigger profit margins than msft) and on the cdo side is maybe 20% (just guessing) so we’re going to split things in some kind of waterfall where the muni side claims are paid out 90 cents on the dollar and the cdo claims get whatever is left, whether it be 18 cents or any other number, as theyre screwed anyway. that is, if the liability mismatch is so huge that even devoting 100% of premium income to cdo claims leaves them f–d then might as well cover most of the muni claims with the rest going to cdo.
BUT THIS STILL DOESNT EXPLAIN WHERE THE AUTHORITY IS TO STEP IN UNLESS THERE IS A THREAT TO CLAIMS PAYING ABILITY…
AND IF THERE IS SUCH A THREAT, WHY ISNT NY PROHIBITING UPSTREAMING DIVIDENDS FROM THE MONOLINE TO THE HOLDING COMPANY?
DO YOU GUYS KNOW THAT EXECS GOT $700K TO $800K BONUSES END OF YEAR AND FROM WHAT I UNDERSTAND MBIA AT LEAST STILL INSISTS IT HAS SUFFICIENT FLOW TO CONTINUE UPSTREAMING DIVIDENDS?
WHO EVER HEARD OF IT BEING SIMULTANEOUSLY TRUE THAT THERES ENOUGH MONEY TO PAY DIVIDENDS AND BONUSES BUT SO LITTLE THAT WE NEED A STATE TAKEOVER???
sorry for the caps but im kind of agitated about rewarding incompetence (including by making the clueless insurance commissioners)
I believe the economic, as opposed to the legal, case for splitting the monolines in two is that, combined, there is a loss of value to both halves, such that both would be better off with a split-up. If the muni business retains its business on an AAA basis, with which new policies can be written, as well, that doesn’t just shore up the muni markets, but it increases the available revenues for paying of remaining contingent liabilities on the structured finance policies, even if the AAA rating is lost for good and considerably down-graded, as is only realistic anyway. The bolstering of the fictitious AAA rating is lost to structured finance policies, as is inevitable anyway, but, in exchange, due to a healthy muni business, more of the losses on structured finance policies are likely to be paid off, if still incompletely so. Granted, there is still a coordination problem here, in aligning individual interests to the overall net gain, which is expressed in the legal entanglements.
The splitting of the monolines into good and bad pieces is fraud, since the swaps were issued by an entity that had a triple-A credit rating, not some yet-another crappy hedge fund.
If it goes through, it has enormous precedent consequences. Any entity that goes through hard times can simply split into good and bad, leaving creditors stuck with toxic garbage, while taking the good stuff. As the result, the credit market will seize to exist.
the not paying divs to the parent is Ackman’s gripe.
Could the split simply be a necessary prelude to the federal government bailing out the muni half? (or offering loan guarantees to it, like Chrysler back in the day).
It would be well worth the government’s while to offer such loan guarantees, because the amount required (perhaps as low as single-digit billions) is already probably overshadowed by the global cost of the current turmoil and frozen muni auctions, and in any case would involve far less cost and far more bang for the buck than the various dubious economic stimulus packages already approved or pending.
However it would look very bad if any part of such a federal bailout went to rescuing the proverbial “Wall Street fat cats” who created the whole structured mess. It wouldn’t be acceptable to have any public money going into the structured half, or the unsplit company. Appearances must be maintained and perceptions managed, especially in an election year.
How to get the policyholders of the structured half to go along with it is a problem, true, but probably not insoluble. Maybe just split the companies in a way that is more generous than strictly necessary to the structured half, throwing them a bone to keep them quiet, knowing that the subsequent federal bailout will compensate the muni half. Or, since those policyholders are mostly major Wall Street players, just browbeat and threaten them, in the grand old Giuliani/Spitzer tradition. Unless the aforesaid players are absolutely sure that every single one of their CDO transactions in the runup to the crisis will stand up to extremely muscular intensive scrutiny, they will probably have to cave.
Not sure if Yves covered this earlier, but Ambac seems very eager to go the split route (FT) they’re proposing to split the business but to let the muni profits pay off losses on the structured side. so it sounds like some SIV concept in reverse.
frankly, agree with max, who wants to be saddled with the toxins when someone else gets the beef, so to speak. Setting bad precedents is probably the last thing on their minds but do they really want to set a case study example they’re going to have to fight against in future?