Sell Side

Ambac, MBIA Eye TARP

With Congress releasing the next $350 billion of funding for the Troubled Asset Relief Program at the request the Bush administration and the incoming Obama administration, bond insurers Ambac Financial Group Inc. and MBIA Inc. are hoping their efforts to get a piece of the pie pay off.

Working with regulators and lobbyists, Ambac has asked the government for a $1.5 billion capital injection through preferred equity that it would use to recapitalize muni-only insurer Everspan Financial Guaranty Corp. - the old Connie Lee Insurance Co. But given the difficulties the companies have had, critics - including the insurers' healthier competitor, Assured Guaranty Corp. - say equity injections would be inappropriate.

Ambac executives say that along with $500 million put in by their firm, a $2 billion insurance company could support between $25 billion and $30 billion in public finance issuance its first year.

"By putting it into Everspan, Ambac's muni-only guarantor, you're assured that 100% of the money that goes in is going to help the municipal market," Everspan chief executive officer Douglas Renfield-Miller said.

But Assured has told federal officials that the companies don't deserve the equity injection they're asking for. The company says using the capital purchase program to aid the monolines is not in line with Treasury's objectives. "It's not clear that additional equity would address investors' lack of confidence in these companies, given that they continue to have significant exposures to troubled asset classes," it said.

"We don't think it's appropriate for CPP money to be made available to bond insurers because it's contrary to what the program is intended to do: provide otherwise healthy companies with the liquidity and funding so that they can make loans," Assured Guaranty president Michael Schozer said. "It's not there to resuscitate companies who are financially impaired, which is the situation in our industry."

What both sides can agree is that the market demands credit enhancement. Insurance penetration fell to 18.4% in 2008 from 46.8% in 2007 as insurers were downgraded, a number below investment grade.

But Assured said that the market has responded well to the troubles at the bond insurers. Other providers credit enhancement have stepped up - letters of credit use increased 240.2% in 2008 - and companies such as Berkshire Hathaway Assurance Co. and Municipal and Infrastructure Assurance Corp., co-sponsored by the Macquarie Group and Citadel Investment Group, have entered the market.

Others, though, say letters of credit are not a perfect substitute for bond insurance. And Berkshire has maintained a low profile in the market, while MIAC is not yet rated and writing business.

Further, Ambac executives said that although the company expects a municipal-only insurer could achieve steady returns in the "low teens," the time required to earn them could deter private equity firms from starting a new insurer.

"You can't readily extract capital it once it goes in, as Blackstone learned with [Financial Guaranty Insurance Co.]," Renfield-Miller said. "It also takes a very long time to really build up returns, because the capital must all go in up front while the portfolio builds gradually over time. Once the book is built up it's a great business, but it takes five to seven years to achieve this steady state."

Ambac has for months planned to recapitalize Everspan. It wanted to begin writing business as early as Oct. 1, but delayed an $850 million injection into the company when Standard & Poor's placed Ambac Assurance Corp. - now rated Baa1 by Moody's Investors Service and A by Standard & Poor's - on review for downgrade in September. Ambac has worked in a coordinated effort with MBIA and insurance regulators from New York and Wisconsin, where the two insurers are based, to ask federal officials for assistance.

Everspan would leverage the public finance experience at Ambac, executives say. The company will have about 40 to 45 employees, including the origination and underwriting team from Ambac along with certain risk management and general management staff. Everspan will also have access to Ambac's 60 to 70 person surveillance team through an arms-length service contract, much like it will have for accounting and other functions.

Everspan is taking steps to convince investors and rating agencies that it will have independence from Ambac. Its risk management team has brought in people outside the financial guaranty industry to provide a new perspective, including chief risk officer Judy Slotkin from Citigroup. Its board will also have a majority of independent directors, primarily drawn from the public sector, with super-majority decisions needed.

It addition to giving investors the assurance of the timely payment of interest and principal, bond insurance has helped provide liquidity to the market. With the economic downturn putting pressure on municipal issuers, the guarantee of bond insurance and the extra set of eyes it provides could attract investors, executives said.

Ambac believes Everspan - which already has licenses in 49 states as Connie Lee - could be up and running within 30 to 45 days of receiving TARP money. Everspan is a separate muni-only insurer beneath Ambac Assurance in the corporate structure, and profits would benefit existing Ambac policyholders before accruing to shareholders.

"Market has higher risk than it did a while ago, so we think this is great timing," Renfield-Miller said. "The need for a financial guarantor is probably greater than it's been in a very long time."

It's not yet clear, though, whether investors will actually accept a new insurer linked to Ambac in any way. Even on debt backed by Assured and FSA - which trades at premiums - investors are taking a closer look at the underlying credits, market participants said.

"Retail loves insurance, but more and more retail is getting accustomed to the concept of focusing on underlying ratings and ignoring insurance," said Janney Montgomery Scott LLC fixed-income strategist Guy LeBas. "It's one they've sort of been burned once [by the insurers], and don't want to go back."

Ambac is trying to generate demand for Everspan guarantees. It has held more than 50 face-to-face meetings with investors to convince rating agencies there is an interest. It plans to increase its marketing efforts and offer "real-time accountability" through transparency efforts, such as posting its entire book of business online.

"Investors are naturally cautious; however, they also said if Everspan's a highly rated and stable financial guarantor, yes, they'd certainly look at it," Renfield-Miller said. "At the end of the meetings, they said we're rooting for you, we need capacity."

But some say the federal government has better options for using the TARP money in the guarantee space. Matt Fabian of Municipal Market Advisors said the current market needs bond insurance, but that Treasury or Federal Reserve would be taking risks by propping up the "out-of-favor" monolines.

By giving money to MBIA and Ambac, the federal government risks that their credit profiles continue to deteriorate, he said. In addition, the companies face credibility problems, and it's unclear investors would be interested in the paper minus a complete federal guarantee, Fabian said. He added that helping the existing monolines would also undermine healthy competitors and deter new companies from entering.

A report recently released by an industry commission convened by the National League of Cities suggested that local issuers investigate starting their own national mutually owned credit enhancer. Oklahoma Treasurer Scott Meacham wrote in a letter the governor that the state should consider creating its own guarantee fund, modeled after the Texas Permanent School fund.

In a hearing with the House Financial Services Committee, Federal Reserve vice chairman Donald Kohn told representatives who had asked him about aiding the downgraded insurers that it was one option for helping the municipal market, but he didn't "know that that particular way is the best way."

House Financial Services Committee chairman Barney Frank and Rep. Gerald Connolly, D-Va., earlier this week suggested the federal government provide some form of credit enhancement. Connolly said the government could directly provide the credit enhancement or form a national insurer.

LeBas said aiding Ambac or MBIA would not fit with what the federal government's TARP plans. He said his firm puts a low probability on a recapitalization because any systemic damage that has occurred because of problems at the firms has already happened. It appears as though the firm has too damaged a name to write new business, even through a new muni-only subsidiary, LeBas said.

"So at this point it's kind of throwing money at something that will help the companies, it would help the customers, but it doesn't really help the financial system or the economy," he said. "And clearly the government's motivation is to do just that."

Others avenues of support could include splitting off the guarantees on toxic assets with enough capital to placate bank counterparties and then recapitalizing the existing public finance book, supporting current policyholders, and, ideally, new public finance business.

The insurers' regulators say they could support some form of support to the bond insurers that way. New York insurance commissioner Eric Dinallo said the insurers already have the expertise to write new business and that helping them would aid all tax-exempt credits, rather than just local municipalities.

"Of all of the proposals I've heard, I think it offers the biggest bang for the buck," Dinallo said. "For several billion dollars, you could have two underwriters back in the market at triple-A doing wraps for all these municipalities that are trying to get off the ground. And that's remarkable and could have a huge impact on helping unthaw the credit freeze."

If Ambac does not get TARP money, it still plans to capitalize Everspan, albeit it with less capital. It believes it can survive, but thinks it can better service the municipal market with the money.

"We are a viable institution with or without the TARP money, but we would be a lot more effective with the TARP money," said senior managing director Diana Adams, who has led the efforts in Washington.


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