In any divorce, dividing up the assets can be a complicated and lengthy process, often accompanied by a mass of legal issues. The same appears to hold true when a bond insurance company is taken apart.
Much of the news in the structured finance market last week focused on the splitting up of the monolines' book of business. This was the case after FGIC announced that it is attempting to separate out its municipal book of business from its structured finance assets or, as many industry participants have put it, weeding out the "good" from the "bad."
MBIA agreed that guarantors should separate out their municipal businesses. Last Thursday, the monoline said it had left its trade group due to a difference in opinion in the direction of the industry.
Ambac is also supposed to be considering separating its businesses. Spokeswoman Vandana Sharma would not confirm the rumor but said the company is currently looking at all its options.
But a slew of litigation could prevent such transactions from coming to fruition, analysts said, expecting umbrage on the structured finance side.
"Litigation possibilities are tremendous problems," said Jim Ryan, equity analyst at Morningstar. "The insureds in the structured finance area can make a very solid case that when they bought the insurance from the company, they were relying on the full faith and credit of the company, and now a certain portion of it is being taken away."
Those exposed to the structured finance book of business have a reason to complain. The counterparties that are holding the structured finance exposure, which are primarily banks and securities firms through credit default swaps and insurance policies, would be forced to take a haircut, market participants said.
The structured finance book of business would deserve a lower rating that would likely jump-start write-downs, market participants agreed, though the degree of losses would depend on the downgrade.
Standard & Poor's acknowledged the separation risk in a company statement. "In our view, it is possible that [a new public finance business] may result in the allocation of capital or other corporate resources in such a manner that other classes of policyholders may be disadvantaged."
Less Money, More Problems
Covering losses in the damaged business could be a major issue for the newly separated company. "It is a little hard to imagine how the bad insurer' could be adequately capitalized when the pre-split combined insurers are having terrible challenges being adequately capitalized as a whole," said Donald Light, senior analyst at Celent.
Indeed, share prices have been depressed as a result of the overhang of CDOs. This has detracted from an amazingly good book of business for municipals and high-grade corporates, Ryan said.
But the separation of businesses is not a regular problem-solving method used in the insurance market, if at all, according to Light. He gave the separation a fifty-fifty chance of coming to fruition. "While the insurance departments can and do take over insurance companies that become insolvent or are about to become insolvent, splitting the book of business between a good book and bad book to my knowledge has not been done, and I am not aware of either statutes or regulations that permit that."
However, that does not mean such a transaction cannot be done, especially if the separation was mandated by the insurance commissioner, which might get the monolines off the hook in terms of legal responsibility, according to Ryan.
A push from the regulators could provide the fuel to get the separation process up and running. "If various government officials, including bank regulators and the U.S. Treasury, think there could be a big chain reaction if the bond insurers go under, then a lot of people will do a lot of things to try to avoid [this consequence], which is the reason why it might actually happen," Light said.
The monolines might also be able to argue the case that they made the separation for the survival of the company, Ryan said. This includes insulating some of the customers, managers and employees from the problem by extracting the "good" business.
As for those exposed to the "bad" book of business, there are several risk mitigation options other than litigation, which might only slow the process down and not stop it, Light said. These include contributing capital to the new entity - which banks including Citigroup and UBS are speculated to be in the process of planning - taking the write-off and letting the capital adequacy and rating issues play out or negotiating a deal to receive a certain amount of cents on the dollar for their exposure. "[Counterparties] remain in negotiation mode; there is just a smaller pool of capital to be negotiated over because a significant amount of capital has been segregated off," Light said.
Writing new structured finance business to raise capital will also be downsized as bond insurers not only struggle with doubts about their credibility, but revert away from the complex securities including derivatives. MBIA said it would exit the derivatives business last week, said returning Chief Executive Officer Joseph Brown in an interview with ASR's sister publication Bond Buyer.
Structured finance insurance is not a completely closed door for the monolines. Also under the umbrella term are corporate bonds and asset-backed securities such as credit cards, auto leases and aircrafts. "There are all kinds of different [businesses] that are right in the middle between municipal bonds and CDOs," Ryan said. "I do not think they are going to become a pure bond company; they are just not going to go to the far reaches of risk that they did in structured finance."
While Ambac would not comment as to whether or not it would be splitting up the company, the bond insurer said it would need to readjust its business model because of current market changes in the structured finance industry.
"The structured finance market is going through its own definition of what it looks like," said Ambac's Sharma. "For the CDOs that were such a big part of the structured finance world, that whole segment needs to be redefined. When we say what we are going to do in the structured finance space, we have to revisit the lines of business that make sense, we have to see what risk adjusted returns we can get, we have to see where the opportunities are and also where our expertise is," Sharma said. However, there will be no run-off of either business if a separation is decided upon, Sharma said. She also maintained that a company separation would not divide the business into a "good" and "bad" bank but instead benefit all shareholders.
However, separated out, the municipal businesses of the monolines would almost certainly retain their triple-A, revenue-generating business model, market participants said. "The municipal business is golden," Ryan said.
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