Sell Side

Buffett’s Berkshire Insures First Bonds

Warren Buffett’s new bond insurance firm, Berkshire Hathaway Assurance Corp., made its first foray into the municipal market last week, insuring a block of bonds in the secondary market for Goldman, Sachs & Co., according to market sources. Several other broker-dealers reported having meetings with the new Berkshire insurance company, saying it is in their interest — and the market’s — to introduce a new high-quality insurer to the municipal market. Berkshire, meanwhile, said yesterday it would not rule out the possibility of buying one of the existing monolines. “We have a vested interest in their business model succeeding, just like any broker-dealer,” said a director at one Wall Street desk. “What this industry needs right now is someone with that sort of stature and immediate name recognition to come in and say, ‘Whatever is happening in other parts of the credit world, we don’t believe that munis should be directly affected.’ ” In what the director called a “bragging-rights transaction,” Goldman bought insurance on more than $10 million of general obligation bonds issued by New York City, paying a premium of 24 basis points to the market’s newest bond insurer. The bonds mature in 2019 with a 5% coupon and are callable at par in 2017. Market sources report that Goldman was offering the insured bonds to various broker-dealers on the Street as early as Friday, though others said potential trades have been slowed by the process of making sure the credit enhancement is processed and a new Cusip is issued for the bonds. The secondary market insurance is Berkshire Hathaway Inc.’s first try at insuring the municipal market, after Buffett announced late last month that he was starting up a financial guarantor to insure only municipal bonds. “Now that there is a license in place, now that there is a parent guaranty in place, and now that there’s a real bond in the market that has his name on it, it’s no longer hypothetical,” said the Wall Street director. Ajit Jain, who Buffett has put in charge of the new insurer, told CNBC today that the company is pursuing a number of options. “We just want to be able to access the market in as many different ways as we can,” Jain said in an interview on the cable business channel. He declined to comment in a phone interview on whether Berkshire was looking to buy an exiting insurer, but added that he still hopes the Berkshire company can be a source for its new competitors’ reinsurance needs. Jain added that he is interested in the prospect of insuring New York deals in the primary market, too. “We’d like to look at general obligations and things that are lower risk, like the water authority,” he said. However, some market sources expressed surprise at the premium paid by Goldman. Uninsured New York City bonds are rated Aa3 by Moody’s Investors Service and AA by Standard & Poor’s, and insurance would make the bonds more costly than many were willing to pay. “I would never insure a New York City bond because you are giving up way too much yield on the credit,” said one trader. “Most of us here thought it was kind of expensive.” Early Wednesday, a large block of uninsured New York City 5s of 2022 were traded at a yield of 4.08%. An equivalent bond maturing in 2019 would be offered at about 3.85%, one trader said. Taking into account the 24-basis-point premium, Goldman Sachs would have to trade the bonds at a yield below about 3.61% to make a profit, he said. Market participants have speculated that Berkshire-backed bonds would trade more favorably in the market than those backed by other insurers, though it remains to be seen if they can trade rich enough to make the insurance worth the price. “I just heard about it,” B. Clark Stamper, portfolio manager at Stamper Capital & Investments Inc., said in an interview Tuesday. “I don’t know where they are trading, but I’m sure they are trading richer than bonds that were not wrapped or by the other muni insurers other than maybe [Financial Security Assurance Inc.]” FSA is the bond insurer least affected by the subprime mortgage fallout. Along with Assured Guaranty Corp., FSA has become the “market benchmark,” said George Friedlander, managing director and fixed income strategist at Citi, in a recent report. One trader estimated that if FSA insured New York City GOs in the secondary market, it would command a yield of about 3.70%. However, MBIA Insurance Corp. and Ambac Assurance Corp., the market’s largest insurers, have been suffering under subprime-related write-downs. Recently the two insurers have been offering secondary market insurance at a premium of 12 basis points, placing Berkshire’s premium in context, said Matt Fabian, managing director at Municipal Market Advisors. Over the last several weeks, several broker-dealers have been contacting Berkshire about the possibility of secondary market insurance, said one market source. “There’s now an open dialogue between them and trading desks,” he said. Multiple managers at muni capital markets desks reported having met with Berkshire about the prospects of getting secondary-market insurance. “We’re looking through the portfolio right now,” said one manager. “It’s a little limiting that they only have one license — in New York. But I think they’re working hard to get up and running in most of the biggest markets quickly.” Sources said there were some questions as to whether or not a New York license gives Berkshire the ability to offer secondary-market insurance on bonds sold by borrowers from other states. Secondary-market insurance requires that a bondholder place the bonds to be insured into a trust. The trust — typically based in New York — then issues a custodial receipt, which is wrapped by the bond insurer. A spokesman for the New York State Insurance Department said that the department does not restrict guarantors from doing business in other states but that the issue might be handled differently by departments around the country. Jain said his understanding is that Berkshire’s New York license allows it to insure in the secondary market bonds first issued in other states. The Berkshire guarantor does not yet have any insurer financial strength ratings from the three major credit agencies, though Buffett has said his company is in an informal dialogue with the raters and plans to put enough capital into the company to get triple-A ratings. Berkshire Hathaway has triple-A corporate ratings from all three agencies. Several state and local government officials have said they want to use Berkshire’s bond insurance if it becomes available. “Their ability to do this without a formal rating and at twice the price of a fairly desperate MBIA and Ambac makes a very compelling argument,” Fabian said. “I they are looking for a sign of whether or not to participate in the muni market, this is an optimistic sign.” The new Berkshire guarantor got its license at the end of December to operate in New York and has submitted applications in other states, including California and the Commonwealth of Puerto Rico. New York City Office of Management and Budget spokesman Raymond Orlando declined to comment. Goldman spokesman Mike DuVally also would not comment.


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