After last month's announcement that uber-wealthy investor Warren Buffett's Berkshire Hathaway would be starting up a new municipal bond insurer, many industry participants felt that the competition would likely deepen the already strained capital positions of other wrap providers.
It's like "putting the last nail in the coffin for monolines," according to one CDO market participant.
Despite these initial doubts, the new business may even be positive for the pre-existing bond insurers, market participants said. They feel that Buffett's stamp of approval will bring confidence back into the industry.
"His coming into the market is a double-edged sword," said Rob Haines, senior insurance analyst at CreditSights. "He is likely going to be competition [for the other bond insurers] if he expands. But [Buffett] is a conservative, credible investor who is starting up a municipal bond insurer. That is a big vote of confidence in the market and [suggests] that bond insurance will be a viable product."
As one NY-based trader put it, "[Buffett] always picks winners."
Buffett's announcement came after a slew of negative headlines in the industry, making it an opportune time to take advantage of market dislocation, market participants said. The latest list of struggling issuers includes ACA Capital Holdings, which was downgraded to triple-C from single-A last month by Standard & Poor's. MGIC, FGIC Corp., Security Capital Assurance (SCA) and Ambac Assurance Corp. all had their financial strength ratings put on negative credit watch by Fitch Ratings around the same time.
Aside from demonstrating Buffett's confidence in the bond insurance business model, the new startup, Berkshire Hathaway Assurance Corp. (BHA), might also help to improve conditions in the industry if it provides reinsurance, Steve Stelmach, analyst at Friedman, Billings, Ramsey & Co., said in a recent report.
Stelmach suggested the possibility that BHA could provide capital relief to existing insurers by offering reinsurance capacity. Reinsurance is also an expedient way to enter the business since Berkshire might lack the teams of underwriters and loss mitigation staff that other monolines have, Stelmach said.
While the option of reinsurance is something the company is currently looking at, it is still early in the game, said Ajit Jain, president of the reinsurance and specialty risk division at Berkshire Hathaway, who will run the new unit. "We are looking at reinsurance options; it depends on whether we can come up with a structure and a pricing level that works both for our clients and ourselves, but we are certainly working hard on that" Jain said.
No Sign of Relief
However, the market does not seem to be convinced BHA will offer much help to the other bond insurers, at least for now. The companies that would suffer the most from the extra competition will be the relatively less-well-capitalized insurers, such as SCA and FGIC, which, as a result, have less flexibility to compete, Stelmach said. However, bigger names like MBIA and Ambac saw their shares drop on the news of the new municipal bond insurer. Both monolines are now down 75% and 72%, respectively, over the past 12 months, JPMorgan Securities analysts said in a report last week.
Furthermore, until the market gets a better indication of how aggressive BHA is going to be in pursuing municipal bond insurance business, it is difficult to ascertain how much the new entrant is going to impact the market, said David Litvack, managing director in Fitch Ratings' public finance group.
Though Buffett has committed only $105 million in capital thus far, if he is willing to commit a more significant amount - $1 billion to $2 billion of capital - it is very likely he could compete very well against these companies and take a lot of the market share, Haines said. "Berkshire obviously has a good track record and tons of financial resources. [Buffett] will be out there pitching business against companies that have legacy issues right now that have not been cleared up. And a municipality would certainly buy bond insurance from Berkshire Hathaway, even at a premium, as opposed to an FGIC and MBIA, at least for the near term."
Testing the Waters
To start off, BHA is looking at a few secondary market transactions, Jain said. BHA insured its first bond last Tuesday when Goldman Sachs bought insurance in the secondary market on $10 million in bonds issued by New York City.
As for the total volume the company expects to write, much of it will depend on pricing and how the initial bonds trade, Jain said. He confirmed that Buffett himself will review all of the potential transactions, at least in the initial stages. This could limit the amount of deals done, but remains in line with the company's starting business plan, he said. "Initially our focus will be on just a handful of deals to see if we can test the market and get our pricing," he said, noting that BHA will focus solely on municipal bonds, at least in the beginning.
Also factoring into business growth is licensing. BHA got its NY license in a matter of weeks, a process that typically takes about nine months, CreditSights' Haines said.
As for getting the same preferential treatment in other states, Jain said he was cautiously optimistic. "Each department has their own procedures and their own rules and regulations, so we certainly hope there is a sense of urgency. New York went that extra mile to make sure we were ready to start insuring New York bonds," he said.
The company will continue to expand its operations into states that are major issuers. "That is where the bottleneck is," Jain said. California, Puerto Rico, Texas, Illinois, Rhode Island and Florida are all potential prospects for the company.
As for expansion internally, the bank is rumored to be buying Financial Security Assurance. FSA spokesperson Betsy Castenir said that her firm doesn't comment on market rumors.
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