Monoline Death Watch: FASB Imposes Strict Rules On Loss Reserves

For those who remember the “monolines on the ropes” days, one of the big bones of contention between critics like Bill Ackman of Pershing Square and industry executives was how to account for the fact that the risks of default on the guarantees the companies had made had increased. Ackman used a conservative mark to market approach and concluded that the big bond insurers, MBIA and Ambac, needed a great deal of additional equity; the companies contented that Ackman was all wet, their contracts did not call for the losses to be paid until well off in the future, and the value impairment was far less than the shorts claimed.

While the industry’s accounting standards are far more permissive regarding impaired credits than that of the banking or securities industry, some of that freedom was whittled away today. Before, remarkably, a bond insurer was not required to increase reserves against a bond guarantee until an event of default, even if there was clear evidence that the credit had deteriorated. Now, moving somewhat closer to practices in other financial institutions, the monolines must increase reserves upon evidence of a rise in repayment risk.

Both Bloomberg and Reuters provided reports. From Bloomberg:

MBIA Inc., Ambac Financial Group Inc. and the rest of the bond insurance industry will have to disclose troubled securities they insured and set aside money for them sooner under new accounting rules.

The Financial Accounting Standards Board will require bond insurers to recognize a claim liability when there is evidence of credit deterioration, rather than waiting for a default, according to a statement today on the group’s Web site. Bond insurers also will be required to disclose securities on their watch lists and provide more information about risk management…

“It will be less of a wait-and-see approach,” according to Russell Golden, Director of Technical Application and Implementation Activities at FASB. “The increase in liabilities will be more commensurate with the increase in credit risk on the underlying exposure.”

MBIA fell 67 cents, or 8.3 percent, to $7.37 in New York Stock Exchange composite trading, after declining 89 percent in the past year. Ambac, down 97 percent in the past year, fell 17 cents, or 5 percent, to $3.22.

The rules, known as FASB Statement No. 163, Accounting for Financial Guarantee Insurance Contracts, are effective for fiscal years that begin after Dec. 15, FASB said. Expanded disclosure on risk management activities is required for the first reporting period after the release…

Bond insurers have used different methods to reserve against claims, making comparisons across the industry difficult, FASB said. Some insurers set aside reserves based on a percentage of premiums received during a period while others reserved based on a drop in the credit ratings of specific bonds they back.

The statement also standardizes how bond insurers are to recognize premium revenue, said Golden…

At least some bond insurers currently set aside reserves only when they believe they can estimate the losses, and the losses are likely to take place. The new rule would force those insurers to set aside money sooner.