Monolines Trying CDO Buyouts

Negotiating from equally desperate positions, the monolines and banks are trying to resolve some ugly business. Lavonne Kuykendall (Dow Jones Newswires 6/23/08 15:44 ET) reports that Ambac (ABK), MBIA (MBI), Security Capital Assurance (SCA), and Financial Guaranty Insurance Corp. [called FGIC] are trying various methods to cancel credit default swap [CDS] contracts on collateralized debt obligations [CDOs]. So far efforts to cancel the contracts by claiming misrepresentations have not been successful in court. Merrill Lynch (MER) defeated Security Capital attempts on seven contracts for $3.1B in face value.

DJ reports the total monoline CDS exposure is to guarantee payments on $125B in CDOs. As the monolines started losing their triple-A ratings, the banks have either written down the underlying CDOs or moved them from held for sale to held for investment. Now that all of the legacy monolines have lost their triple-A, the banks are concerned they will incur additional large reserves. Even though the banks are facing the inevitable counter party risk, they still have been reluctant to accept buyouts.

The tides may be changing. Once banks are forced to increase capital against their insured CDOs, they have nothing left to lose in accepting buyouts. Getting some money from the monolines is better than forcing them into rehabilitation (receivership). ACA Capital Holdings [OTC:ACAH] closed three contracts for a payment of $28.4M.

The pressure on the monolines is also increasing. Once MBIA lost its triple-A, it faces $2.9B in termination payments and $4.5B to collateralize its guaranteed investment contracts [GIC] - a total of $7.4B. Ambac will have to put up $556M.

Standard & Poor’s says that the monolines risk their reputations pursuing buyouts based on their weak positions. It will lessen the value of their insurance to future customers. I think with all the cards now out on the table, the time for saving face is over. The monolines need to clear their books and regain their triple-A credit rating. With that, the customers will return.

Disclosure: Author is long ABK and MBI.

Comments

[Ishortyou]

In respect to AMBAC and MBIA, they need to keep and save all the cash possible including stop paying dividends, deleverage from all their risky liabilities specially those CDS, CDO's, RMBS-ABS of uncertain value, in order to remediate their book values, once their book values are sound they need to reinstate their triple A rating again to write new low risk public bond insurance business. They can also open or extend a line of credit to make sure to continue operations and dissipate doubts.

They are already doing these, so it will take some time to deleverage their books from uncertainties and rewrite new business again. This coming back will be the best advertisement to recruit new clients.

[crashof2008]

Don't EVER assume that MBI's estimate of how much collateral will be required is gospel. That is a hopelessly naive position. It is up to the counterparties to decide whether to demand extra margin. That figure is simply an exceptionally optimistic estimate of MBI.

In terms of MBI and ABK attempting to cancel 125 billion in credit default swaps in intense negotiations with Citibank, Merrill and UBS. Most accounts put MBI's share at 80 billion of this.

Any negotiations to cancel the 80 billion in insurance contracts that MBI wrote will be extraordinarily problematic, especially in this environment of collapsing bank profits.

To understand why, you need to master the difference between a CDO and a CDS. The difference between these two is an absolutely VITAL distinction that so many overlook.

I'll keep it short and sweet. But you need to master this distinction. Read carefully for just 30 seconds and it will serve you well.

Think of a CDS (credit default swap) as an insurance policy. MBI insured 80 billion of largely worthless paper to various banks. They are, after all, an insurance company and thought this would be a logical extension of their insurance business.

Now MBI wants the banks such as Merrill and Citi and UBS to cancel the insurance policies. MBI is basically offering to simply refund the premiums paid.

This would leave the banks holding 80 billion dollars of collateralized debt obligations (CDOs) that had been insured and guaranteed by MBI.

It's like if your house is destroyed in a fire. The insurance company, instead of reimbursing you for the value of the home (say $400,000) offers instead to rebate you the $1200 you have paid in premiums.

Would you take it?

This is what MBI is offering.

[Ishortyou]

it looks that banks will benefit better by accepting the buyouts at this point of the game than sending them to defaults to cash out, simple math dictates that.

[helplessobserver]

crashof2008 has it mostly right. Each CDO is backed up by physical assets that have depreciated, but are not a pile of ashes.

[kiecollpat]

In response to crashof..
Paying out the insurance is the problem.
What if you were sub-letting the house.?(And never told the insurer)



Who appraised the house? maybe its overinflated!!
Who bought the house? are they credit worthy!!
who insured the house ? negative equity another problem!!
how did the house set fire?
Who really lives in the house ?
Is it the primary resident and/ residency?

It is much more complex
than preminums if you dealing with falsehoods