-- Daniel Flatt
Monoline insurers are considering their options to maintain their AAA status, including selling equity to raise capital and reinsuring more of their portfolios. Fitch Ratings and Standard & Poors have recently threatened to downgrade the bond insurers because of their exposure to subprime debt.
Fitch Ratings warned last weekthat many monolines may not meet capital adequacy standards following a review based on updated stress methodology. The agency said that CIFG and FGIC were at a high risk of experiencing erosion of capital, while Ambac and SCA were at moderate risk and MBIA was at low risk. CIFG was already on rating watch negative following an S&P review in June. The cost of buying protection on monolines has risen sharply over the past few weeks.
The downgrade of a monoline could cause a serious devaluation of wrapped deals, said Tim Barker, head of credit research at Morley Fund Management. European investors were warned to sell off wrapped paper in favor of natural AAAs as early as August, (TS,8/28) as subprime fears dramatically affected monoline credit default swaps levels and share price. Analysts at the Royal Bank of Scotland said at the time to maintain an overall underweight in deals underwritten by as financial guarantors at the time. "[CDS levels] have slipped so far, I dont know how they can climb back up," feared one investor who declined to be named.
Although insurers have acknowledged the seriousness of downgrade risk they claim they have a number of solutions in their armory. One senior monoline official who declined to be named said they were actively looking at all options which included raising equity but stressed this was a worst-case scenario. Monolines are not forced sellers of bonds at distressed prices unlike investment banks and SIVs who require posting collateral. Monolines hold to maturity, he said.
Douglas Renfield-Miller,chairman and ceoofAmbac Assurance UK, said other options available include reinsuring more of their portfolio, We have a total exposure to CDOs of ABS and direct subprime of about 7% of the total portfolio, which leave 93% which we could free up for re-insurance... It could improve the credit quality of the re-insurer because they would hold more of the municipal deals rather than the more typical structured finance debt that they prefer. Renfield-Miller added monolines could also slow down origination which would create, in AMBACs case, $500 million to $1 billion of capital through previous risk from earlier transactions that have amortized. Its not a preferred route since we would be slowing down future business but if need be, to preserve ratings, it can be done.
CIFG officials declined comment and representatives from FGIC and MBIA did not return calls. SCA officials could not be reached.