When Ed Grebeck, CEO of debt-strategy firm Tempus Advisors, reads about a multi-billion-dollar bank bailout for insurers, he doesn’t see a path to recovery. He sees the further enabling of damaging, co-dependent behavior among banks, rating agencies and bond insurers.
That incestuous relationship is more tangled than many realize.“The banks are effectively saying to the monolines ‘I have exposure to you because you’ve guaranteed wraps that I am holding,’” he says. The banks bail out the monolines so the rating agencies can say the bonds are still rated triple-A, and thus are guaranteed. Banks thereby avoid more writeoffs or the requirement to hold more funds in reserve. “It amounts to a ‘get-out-of-jail-free card’ for suspect actions all around,” says Grebeck.
These interlocking interests have plenty of implications, but one practical result is a triple-A rating isn’t the same in all cases. A wrapped triple-A-rated collateralized debt obligation with some subprime paper is not the same instrument as a corporate GE loan that is also rated triple-A. This issue has far-ranging legal implications, since the operating requirements of many institutional investors, such as pensions funds, permit only triple-A-rated investments.
“Ratings for a company like GE are real,” Grebeck says, noting the quality of the blue-chip firm. “If you’re investing in GE versus the senior tranche of a CDO, you should really look at the senior tranche of the CDO as equity risk. At that point, I’m going to need a return of a lot more than a couple of basis points over Treasury.” Most structured-finance instruments, he says, are carefully built to earn triple-A ratings.
Who’s to blame? “The rating agencies aided and abetted the process,” says Joseph Mason, an associate professor of finance at Drexel University, who notes that CDO instruments comprises about one-third of rating-agency revenues. “To downgrade the bond insurers is to kill the goose that laid the golden egg,” he says. “But to not downgrade the insurers is to reveal the relationship between the two.” Rating agencies’ opinions on the quality of debt is based, of course, on companies’ posted financials, but the facts are less clear with CDOs. “Those ratings are collaborated on with the issuing investment bank,” Grebeck says. “That is more of a securities underwriting function than an issuance of an opinion.” Calls to the three main insurers — MBIA, FGIC and Ambac — as well as two key rating agencies — Standard & Poors and Moody’s — were not returned by press time.
Monoline insurers are on the verge of receiving a total of more than $10 billion in cash infusions to cover potential losses from claims related to subprime mortgages, but a recent Standard & Poor’s report suggests their exposure could reach as high as $19 billion. Many industry sources contend such infusions won’t be enough to cover insurers’ losses.
A cash infusion and line of credit is being negotiated for Ambac with a consortium of banks, including Citigroup and Wachovia; MBIA has raised several billion dollars from Warburg Pincus. FGIC’s plans are being led by Calyon, the investment-banking unit of Credit Agricole of France, and include UBS, Société Générale, Citigroup and Barclays.
Ambac spokesman Paul Burke says the insurer has backed off plans to divide itself into two, separating the relatively sound municipal side of the business from the troubled corporate side. Instead, Burke says Ambac has suspended its structured-finance business for six months. Dividing the two sides of the business would pose its own set of problems. “If you had purchased bond insurance as a governmental unit or a corporation, you would be a bit surprised to be told that the deal is changing and you’re going to wind up being insured by someone else, and what’s behind that someone else isn’t as good as what you thought when you got in,” says John Weicher, director of the center for housing and financial markets at the Hudson Institute in Washington, D.C. “To my mind, that suggests an invitation to some kind of legal action.”
The most immediate next step toward restoring confidence in the industry may arise from a recently launched Federal Reserve study of the issue, designed to ensure risk exposure is fairly and accurately portrayed to corporate-loans buyers. Regulators, says Mason, should have developed reporting requirements that adequately address banks’ exposure to credit risk. “This should be an election-year question,” he says. “What candidate is going to install teeth in [rules from] regulators?” (c) 2008 U.S. Banker and SourceMedia, Inc. All Rights Reserved. http://www.us-banker.com http://www.sourcemedia.com
