Monoline insurers, MBIA, Financial Security Assurance and AMBAC Asset Assurance, which had ceased writing policies on collateralized debt obligations, are starting to re-enter the market. But they are struggling with accounting issues related to FAS133 and are scrambling to find ways of avoiding taking mark-to-market volatility on their balance sheets, say monoline executives.
Betsy Castenir, a New York-based spokeswoman at FSA, says the monoline has resumed writing policies on CDOs on a selective basis. Officials at MBIA did not return calls. An official in the CDO department at AMBAC said it was involved in CDOs, also selectively.
One idea being proposed is to carve up the super senior tranche to make the mark-to-market risk less problematic, monoline and re-insurance officials say. Another idea is to make sure there is an insurable interest in the deal, meaning that a party will have to hold onto the asset throughout its term. This would entail using another insurance company as a transformer, instead of a special purpose vehicle. Figuring out how to accomplish such a structure will be the "Holy Grail" for the market, says one structured finance expert.
Despite their eagerness, monolines will not underwrite as many deals as they would like to until they can figure out how to structure the financial guarantees to circumvent having to mark the risk to market. Unfortunately, a solution has not yet presented itself. Still, as some of the CDOs already underwritten come to maturity, those positions can be replaced and monolines are selectively writing protection when the mark-to-market charge makes sense.
FAS 133 requires that corporations mark all derivatives positions to market and gains or losses are realized in the current period's income. This kind of accounting treatment makes a monoline's earnings unpredictable and opaque, says one monoline executive. The accounting standard also puts a limit on how much CDO risk a monoline can afford to take on its books, he adds.
Monolines like super-senior risk--the unfunded tranche in CDOs above the triple-A slice--because the likelihood of default is very remote. However, the advent of FAS133 has made this risk less economically sensible. "[FAS133] is a very unhelpful development," notes one monoline executive.
"This is a key issue for insurers. They went long on super senior tranches and the problem is that in swap form, the positions have to be accounted for on a market-to-market basis," says the expert.