Warren Buffett yesterday offered to reinsure $800 billion in municipal bonds now insured by Ambac Assurance Corp., MBIA Insurance Corp., and Financial Guaranty Insurance Co., through his Berkshire Hathaway Assurance Corp.
Speaking live via telephone on CNBC, Buffett gave the insurers 30 days to find a better deal. He said he offered the deal to the insurers last week and that one insurer - whom he refused to name - had already rejected his offer. The other two have yet to respond, he said.
Spokespersons for Ambac, MBIA, and FGIC declined to comment.
In the interview, Buffett said he would seek only to reinsure the low-risk municipal bonds on the financial guarantors' books, choosing to steer clear of the companies' riskier credits tied to collateralized debt obligations or credit default swaps.
Buffett said he estimated that the three monoline companies insure about $800 billion in tax-exempt bonds, and that he was prepared to assume all of their liabilities.
"The municipals, in effect, get taken off the table," Buffett said. "Our system puts the municipals at the front of the line. What's going on now leaves the municipals at the back of the line because the funds will get depleted for all of these other types of insurance before they get to the municipals in very large part."
Buffett also said he would charge a premium equal to about one-and-a-half times the premium left on the life of the bonds, drawing on an example from Berkshire's efforts to reinsure select credits in the muni secondary market where it can command a 200% premium.
Buffett's announcement is the latest in a string of solutions proposed to help bail out the bond insurance companies, the monoline insurers that have seen their capital cushions deflated as losses have risen on the derivative instruments they guarantee. Several groups of investment banks are currently in negotiations to raise capital for the various insurers, led in part by efforts of the New York insurance superintendent Eric Dinallo.
Buffett's latest plan also appears to have the backing of Dinallo, who said in a statement that he was "pleased" with the option.
However, the success of the option remains to be seen. A number of questions would have to be answered going forward if the plan were to take shape, and one insurer's refusal to take up Buffett's offer shows their reluctance.
First, typical reinsurance contracts do not substitute the rating of the new reinsuring company, and bond ratings would continue to be based on the rating of the original financial guarantor. As a result, there is some question about the effectiveness of the plan in assuring municipal market participants that all was back to normal.
"The typical reinsurance contract runs between the seeding company and the reinsurer. Policyholders of the seeding company have no recourse to the reinsurer. They could only look to the [original bond insurer]," said Dick Smith, managing director at Standard & Poor's. "There would have to be some other element present here that gives the policy holder the right to go to the reinsurer."
At the moment, Berkshire is not rated by any of the three rating agencies.
Under the plan, Buffett would only reinsure the safe portion of the insurers' books, leaving them to hold the more risky credits. This would change the business model, and could have negative implications for the triple-A ratings regardless of the capital freed up. All three rating agencies have said their evaluations of "triple-A-ness" rest, in part, on the monolines' ability to write new business and exist as a going concern.
"By reinsuring a large chunk of the municipal portfolio, the bond insurer would be left with an insured portfolio that is more risky post transaction, as the debt remaining would largely be structured finance and international obligations," Andrew Wessel, an equity analyst at JPMorgan, wrote in a note yesterday.
In addition, muni bonds rarely default, meaning that rating agencies require the bond insurer to put up less capital reserves than they would for other asset-backed securities. This means that by offering to reinsure munis only, Buffett is offering the option that frees up the least amount of capital.
"It's easier to see that this is a transaction that would be good for the market," Smith said. "It's harder to see that this is a transaction that would be good for the companies." q