The landscape of the municipal bond insurance industry shifted yesterday, as MBIA Insurance Corp. and Ambac Assurance Corp. were downgraded to AA mere hours after Macquarie Group, the Australian investment bank and infrastructure specialist, was reported to be planning to start a bond insurer.
In downgrading two of the largest bond insurers, Standard & Poor's cited the insurers' lack of new business prospects, poor financial flexibility, and the further declining of the residential mortgage market. The rating agency placed the insurers' ratings on negative watch.
"The rating actions on these companies reflects our belief that these entities will face diminished public finance and structured finance new business flow and declining financial flexibility," Standard & Poor's said in a release. "We believe continuing deterioration in key areas of the U.S. residential mortgage sector and related [collateralized debt obligation] structures will place increasing pressure on capital adequacy."
In a indication that the rating actions and continuing turmoil with the bond insurers could spur federal legislative or regulatory action, said Rep. Barney Frank, chairman of the House Financial Services Committee, said: "In light of today's downgrade of Ambac and MBIA, it is essential that credit rating agencies and investors base their decisions on the fundamental credit quality of municipal bonds and not the rating derived from the insurers."
"Cities and states should not be penalized by the shortcomings of these firms," he added. "If the credit worthy cities and towns become innocent victims, then the case for congressional action will be stronger that it is today."
The action comes a day after Moody's Investors Service placed both insurers' triple-A ratings on watch for downgrade, citing similar factors in its decision. The actions of both rating agencies further damage the insurers' abilities to continue as dominant players in the municipal insurance market. Once two of the largest, MBIA and Ambac have written little business this year because of concerns about their ratings. The two still guarantee billions in municipal debt.
"People that have been following the ratings on the bond insurers shouldn't be overly surprised about Moody's negative watch actions yesterday, and today's downgrades," said Richard Larkin, head of research at Herbert J. Sims & Co. "In December, all three raters went on record as saying that at some point, the prospects for continued new business could become a rating pressure for the bond insurers, and would be added to their concerns about sub-prime exposure."
Earlier this year, Fitch Ratings downgraded both bond insurers to AA.
Meantime, Macquarie Group will start a new company called Municipal and Infrastructure Assurance Corp. Formed with $2.5 million in seed capital, it will be the product of a consortium made up of Macquarie and others, mostly U.S. institutional investors. The new company will insure both municipal and infrastructure credits, and will not have a structured finance component, according to a person familiar with the matter.
Macquarie's plans became apparent in a Notice of Intention first published in the New York Times Wednesday. The advertisement, published in the metro section yesterday as well, listed nine proposed incorporators, five of whom were determined to be employees of Macquarie.
A spokesperson for the bank declined to comment.
Though the insurer has not yet filed for a license, it is expected to do so in the state of New York. According to New York State Insurance Superintendent Eric Dinallo, the company is currently in the midst of the application process.
"We have been engaged with representatives of Macquarie since April," Dinallo said, in a prepared statement. "We welcome Macquarie's decision to form a bond insurer and will continue to work with interested parties to add capacity to this market."
The need for capacity became apparent after ratings agencies began downgrading formerly triple-A rated insurers late last year. It became more acute with Standard & Poor's downgrade of MBIA and Ambac, as it left only Assured Guaranty Corp., Financial Security Assurance Corp., and the new Berkshire Hathaway Assurance Corp. as triple-A insurers. The rating agency said the negative watch would be resolved only as the level of potential losses, business prospects and strategic decisions of the bond insurers, and potential regulatory developments became clear.
On Tuesday, Standard & Poor's downgraded the rating to AA from AAA on Channel Reinsurance Ltd., the single largest reinsurer for MBIA. The downgrade of Channel Re caused Standard & Poor's to recalculate the capital adequacy for MBIA's insured portfolio. With both of the company's at AA, MBIA now gets credit for 75% of its book ceded to Channel Re, said Standard & Poor's analyst David Veno.
"This is risk coming back on the books for MBIA," Veno said.
In light of the downgrade, MBIA and Ambac may choose to pursue setting up separate entities that would insure only municipal bonds. Wednesday, MBIA's chief executive officer, Jay Brown, said the company may accelerate its plans to set up a muni-only insurer and seed it with $900 million of capital currently sitting at the holding company level. On Thursday, Ambac said it was accelerating its plans to launch a new triple-A rated financial guarantor utilizing its subsidiary, Connie Lee Insurance Co. It will be recapitalized with surplus capital from Ambac Assurance and, potentially, other parties, the company said.
"We [believe], based on its proposed capitalization and business plan, the new Connie Lee will receive regulatory approval and will attract stable AAA ratings," said Ambac CEO Michael Callen.
Either way, it looks like they will have to compete with another new entrant into the market, the first since Warren Buffett started Berkshire Hathaway Assurance Corp. earlier this year. And others are also interested in getting involved, though it is not known whether those who have expressed prior interest are involved with Macquarie.
Some sources have suggested that Macquarie would work with large domestic pension funds in the U. S. While many market participants have suggested that the pension funds get involved, and the California Public Employees' Retirement System has shown interest, it is not clear how the deal would work.
One market source said the pension funds would not be likely to invest in the new company through buying shares, as many of them probably invested in MBIA and Ambac or other publicly traded insurers in the past. If that's the case, and the funds have real reservations, then the they are more likely to be involved through a private equity type arrangement, where they would have to agree to having their funds locked up for a period of time, say three years, said one source with experience dealing with pension funds.
"We cannot say anything publicly," said Clark McKinley, a spokesman for CalPERS in Sacramento. "We don't have anything for publication at this point. That doesn't mean one way or the other that we are or we aren't planning on doing something."
Tom Dresslar, a spokesman for California Treasurer Bill Lockyer, who sits on the Board of Administration for the pension plan, said the retirement system is "still studying the issue." The issue has not come to the board yet, suggesting it's too early for any actual investments to be made, he said.
Last week, private equity firm Ripplewood Holdings LLC was also said to be interested in getting involved in the bond insurance industry. It is not known whether the firm is involved in the Macquarie deal.
Regardless, any new entrant into the market must get a triple-A rating from the three rating agencies in order to be competitive. After several months, Buffett's bond insurer was able to do so, but others will have to meet the same standards.
"The real question is can you get the triple-A rating," said Wilbur Ross, head of WL Ross & Co., who invested $1 billion in the Assured Guaranty "I think [the MBIA and Ambac] downgrade illustrates the carefulness with which the rating agencies will decide whether to give anybody a triple-A."