VOL. 122 | NO. 162 | Tuesday, August 28, 2007
Bond Insurers See Ill Winds
By SARAH CHILDRESS | The Wall Street Journal
When a hurricane slams into Florida, investors dump shares of companies that insure homes. When a storm of defaults engulfs the bond market, investors naturally sell the companies that insure bonds. In both cases, the selloffs are often overdone.
As the bond-market mess grew this summer, investors dropped shares of the largest insurers. Ambac Financial Group Inc. took the biggest hit, falling 38 percent from the beginning of the year. MBIA Inc. fell 30 percent, and Assured Guaranty Ltd. slid 16 percent.
"The selloffs from the stock are unprecedented in their speed," said Heather Hunt, an analyst at Citi.
While the share prices have since rallied from their lows, they remain down for the year and their valuations are right near their historic lows.
Bond-insurance companies guarantee debt securities. For a premium, they agree that if a bond defaults, they will assume the principal and payments throughout the life of the bond, saving the bond issuer from shouldering the debt. They tend to be choosy about the level of risk they will insure, but with the recent subprime fallout, investors are afraid that guarantors haven't been discerning enough.
These companies are used to investors hitting the panic button. After the Sept. 11, 2001, terror attacks and Hurricane Katrina in 2005, the market also dropped bond-insurance shares, anticipating that the guarantors would post huge losses. None did, but it didn't calm the market's jitters right away.
"Their stocks tend to be volatile in times where there is an event that people can't get their arms around. They assume it's only the beginning of similar events," said Dick Smith, an analyst at Standard & Poor's Ratings Services.
Investors may have been too hasty in dumping shares this time, too, some analysts say. These companies had minimal exposure to subprime residential mortgages, according to a report by Tamara Kravec, an analyst at Banc of America Securities. And because they typically apply tougher underwriting standards and hold higher-grade portfolios than the rest of the market, they should fare better than the overall market in terms of losses.
That isn't to say shares of these companies will follow a smooth slope upward. Bond insurers will most likely have to shoulder losses for some mortgage securities, and things may look bad at different periods. But ultimately their payments, which will be spread out over a long period, will be manageable.
"The business model of the (bond) insurance companies is that they worry about the actual payments they're going to make going forward as opposed to mark-to-market hits," said Matt Sauer, a portfolio manager at Ariel Capital Management LLC, the largest investor in Assured Guaranty. "It's a potential that they're going to sustain some losses ... but they're going to weather this."
Wall Street's biggest concern in the subprime meltdown is those mortgages written in 2005 and 2006, when lending standards were most lax. MBIA, one of the largest insurers, stopped underwriting subprime mortgages in 2004 unless they were rated triple-A, meaning they would be least likely to default. The company holds $5.1 billion in direct subprime residential mortgage-backed securities, equal to about 0.8 percent of its total portfolio.
"In general, we are pretty comfortable with our subprime exposure," said Chuck Chaplin, MBIA's chief financial officer.
Assured Guaranty officials were also concerned about the shaky credit market, also deciding in 2004 to underwrite only triple-A-rated subprime residential mortgage securities. "For our own book of business, we're very comfortable," said Sabra Purtill, managing director of investor relations and strategic planning at Assured.
The company reported $6.7 billion in U.S. subprime residential mortgage-backed securities, which is 4.7 percent of Assured Guaranty's portfolio. Ms. Hunt at Citi recently upgraded its stock from "hold" to "buy/high risk."
Ambac has $9.3 billion in direct subprime residential mortgage-backed securities, about 1.7 percent of its portfolio. With a greater share of particularly risky debt, Ambac has seen its share price struggle more than its rivals'. The company underwrote $2.7 billion of subprime RMBS in 2005 and 2006, with a weighted average rating of double-A in 2005 and triple-B-plus the following year. Sean Leonard, Ambac's chief financial officer, said the company was "comfortable" with its exposure, considering that "virtually all the transactions in those portfolios" had investment-grade ratings.
In a "worst-case" scenario by Banc of America's Ms. Kravec, these insurers would have losses of less than 10 percent of their claims-paying resources. That scenario assumes that the companies' portfolios aren't diversified, and that the collateralized-debt obligations they insured would be wiped out all at once, which is very unlikely.
For MBIA, that would mean a loss of 3.6 percent of book value, for Assured Guaranty, it would be 15 percent of book and for Ambac, 44.5 percent of book.
But in the far more likely base case scenario, MBIA's losses would be negligible; Assured Guaranty's would be 7.8 percent of book and Ambac's 2.8 percent of book. These numbers are far better than the worst-case scenario because guarantors aren't required to post collateral for mark-to-market losses. So even if a bond they have insured defaults, they pay only the principal and payments over the life of the bond.
While these companies' stocks have recovered a bit from their plunge a few weeks ago, they are still cheap compared with their historical valuations. Assured Guaranty has a price-to-book ratio of 1.07 compared with its historical average of 1.04. Ambac has a price-to-book ratio of 1.08 compared with 1.65. MBIA's price-to-book is 1.12 compared with an average of 1.52.
The stocks remained volatile, even as the overall market has recovered. MBIA's shares were at $58.69 as of 4 p.m. Friday in New York Stock Exchange composite trading, down $1.39 or 2.3 percent; Ambac was $63.45, down 67 cents, or 1 percent, and Assured Guaranty was $27.25, up 41 cents, or 1.5 percent.
Mark Mulholland, president of Matthew 25 Management Corp., snapped up 6,500 shares of MBIA a few weeks ago when prices plummeted, calling the buy a "no-brainer." He's invested about 10 percent of his $94 million portfolio in MBIA.
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