The third quarter of 2008 brought a dramatic reorganization of the global banking system and a virtual shutdown in the credit markets. Financial guarantors, which have been battling downgrades for months now, have seen new structured finance opportunities seize up.
However, monolines remain optimistic that the securitization industry will return, and when it does, bond insurers will be poised for a comeback.
Indeed, the present tumultuous market conditions have made it difficult for any issuer to put a transaction together. Last week, triple-A student loans and triple-A credit cards widened by 25 basis points and 50 basis points, respectively, according to JPMorgan Securities research. Unless one is a top prime issuer, there is very little in the way of liquidity, market participants said.
Making matters worse, between October 2007 and Oct. 9, 2008, 237 ABS CDOs with a total aggregate issuance of $253 billion tripped their event-of-default triggers, according to data from Standard & Poor's cited in a Wachovia Securities report. ABS CDOs in default represent 33% by count and 40% by volume of total ABS CDO issuance since 2002. These defaults equal 13% by count and 21% by volume of total CDO issuance.
But some well-capitalized monolines are standing by the asset class, despite the lull in deal flow. Assured Guaranty, which currently retains a triple-A financial strength rating from all three major rating agencies, said it remains committed to the structured finance business on both a domestic and a global basis. The lack of new issuance is a market issue and not reflective of the appetite for risk in this asset class, the guarantor said.
On the other hand, Financial Security Assurance (FSA), the only other monoline to hold a coveted triple-A financial strength rating from the three major rating agencies, and its parent company Dexia Group, decided to exit the ABS business in August to focus solely on the public finance business. The firm cited continued "credit deterioration in the residential MBS portfolio and general economic conditions."
At the time of the announcement, the firm reported net losses of $330.5 million for the second quarter of 2008 and $752.1 million for the first half of the year, due primarily to charges from its financial products investment portfolio and losses in its financial guarantees of second-lien RMBS.
What Goes Down, Should Come Up
But the ABS market must come back, industry participants agree, which should help restart demand for financial guaranty insurance. "You will see resilience in some of these assets, because the Federal government can't and won't become the lender for corporations on a long term basis - that has got to undo itself once the market comes back," Michael Schozer, president of Assured Guaranty, said. "But people will still need money for a car, though maybe less than before because there will be less leverage."
Furthermore, the Economic Stabilization Act, including the Troubled Asset Relief Program, will also generate liquidity as bank balance sheets are recapitalized, and as the government injects equity into financial institutions through stock purchases.
This has certain monolines confident that there will be opportunity when the appetite for ABS recovers, especially because many monolines have followed through on their contracts, said John Dare, managing director and head of structured finance at MBIA.
"The value of financial guaranty insurance has been demonstrated. We have met the promises embedded in our insurance contracts by paying on a timely basis principal and interest when due on securities that we guaranteed," Dare said. "Though a number of issues need to be resolved within the ABS market, we expect that when investors look back and realize that insurance did what it was supposed to do, the desire and demand for financial guarantees will return."
Dare said that employment of ABS deals as a funding mechanism will build back up pace. "Excluding RMBS - which is going to see a lot more government intervention and involvement - I think a lot of the other markets will and do need to come back and the ABS market will act as that funding conduit for them."
There will also be a likely absence of structured credit deals in the monoline business model, as the originate-to-syndicate model is gone from the new issuance ABS market, at least in the foreseeable future.
Furthermore, guarantors have widely agreed that the concept of doing resecuritizations and being active with arbitrage is not in line with their current goals and objectives.
For the time being, for most of the guarantors the focus is on surveillance of existing deals and claims-paying ability. "Monolines are doing what they can to work through their problems," said Jack Dorer, managing director in the financial institutions group at Moody's Investors Service.
"We are devoting a tremendous amount of resources to our surveillance areas," Dare said. "This is to ensure that we can take active and early remediation steps to avoid loss if necessary."
Companies with substantial deterioration are working to preserve their claims-paying resources, said Arlene Isaacs-Lowe, senior vice president in the financial institutions group at Moody's, citing the reinsurance transaction for FGIC with MBIA.
Earlier this month, MBIA announced the close of a reinsurance deal between its insurance subsidiary, MBIA Insurance Corp. and FGIC. In the deal, MBIA purchased a U.S. public finance portfolio with total net par outstanding of approximately $166 billion from FGIC. As part of the transaction, MBIA received unearned upfront premiums, net after a ceding commission paid to FGIC, of approximately $639 million, which will help the firm remain sufficiently capitalized.
Syncora Holdings, formerly known as Security Capital Assurance, announced this month that it has tapped JPMorgan as an advisor to assist Syncora Guarantee in identifying strategic alternatives for its portfolio of credit default swaps and financial guarantee contracts.
In September, CIFG Holding announced that it had commuted approximately $12 billion in notional ABS CDO and CRE CDO exposures in exchange for cash and equity. The monoline also said it will seek to reinsure its public finance portfolio with a double-A rated insurer, thus providing municipal investors with important new enhanced protection.
Also in September, ACA Financial Guaranty Corp. announced a reorganization with a new Board of Directors and chief executive officer, in connection with the complete restructuring of its balance sheet and obligations, approved on Aug. 8. As a result of the restructuring, ACA Capital Holdings will no longer control ACA Financial Guaranty Corp. The latter will now be controlled by a group of certain former counterparties to the transactions guaranteed by ACA.
While the overall ratings outlook for the guarantors remains case specific, Dorer said, as part of its review process, Moody's takes into account capital adequacy, future franchise strength and the potential profitability of the firm, as well as financial flexibility.
Those companies that are seriously damaged, whose ratings have been downgraded significantly and have uncertain outlooks, as well as questionable capital adequacy, include FGIC, Syncora Guaranty, CIFG., ACA Financial Guaranty Corp., and Radian Asset Assurance, according to S&P.
Hungry For Muni Debt
Meanwhile, there is still demand on the public finance side for stable financial guarantors. "We have been writing public finance business," Schozer said. "Since we cannot control the market, Assured has the flexibility to adapt and adjust as we can. The expression might be: Take what the market gives you."
Both Ambac Assurance Corp., under the name Connie Lee, and MBIA have announced plans to launch new subsidiaries focused on U.S. public finance, according to S&P.
But these new entities will face challenges, according to S&P, including finding a top-notch management team.
"Only a finite number of seasoned executives have the requisite experience to take on the senior management responsibility of a bond insurer," the rating agency said.
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