Shares in US Bond Insurers Rise on Bailout Hopes

January 25, 2008

Shares of bond insurers rose sharply Thursday on hopes the sector could receive support from a possible bailout orchestrated by New York insurance regulators.

Shares of Ambac Financial Group Inc. rose $1.49 (euro1.02), or 10.9 percent, to $15.19 (euro10.36) in early trading Thursday. Security Capital Assurance Ltd. shares rose 22 cents, or 5.8 percent, to $4.01 (euro2.73). Shares of Assured Guaranty rose 7.6 percent to $22.20 (euro15.14). Only MBIA fell, dropping 4.2 percent to $15.91 (euro10.85).

On Wednesday, New York insurance regulators said they were working on a plan to help bond insurers attract more capital and increase capacity, including meeting with major banks to discuss the potential for a rescue plan.

Friedman, Billings, Ramsey & Co. analyst Steve Stelmach wrote in a research note Thursday a bailout could entail investment banks providing $5 billion (euro3.41 billion) immediately to help struggling companies. That could satisfy capital shortfalls at FGIC, Security Capital Assurance and Ambac.

The investment banks could pour in an additional $10 billion (euro6.82 billion) in the future, Stelmach said.

Ambac’s crucial financial strength rating was already downgraded to “AA” by Fitch Ratings from “AAA,” while Security Capital Assurance is likely facing a downgrade as well after scrapping capital raising plans earlier this week. Bond insurers essentially need a “AAA” rating to generate new business.

MBIA has already raised about $2 billion (euro1.36 billion) through private and public offerings in an effort to maintain its “AAA” rating.

Stelmach said the best bailout option would be a reinsurance plan with investment banks providing the capital.

“Reinsurance would clearly weigh on earnings until the reinsurance capacity was no longer needed,” Stelmach said. “However, current shareholders would benefit from no permanent dilution to book value.”

Other options include direct capital investments into the struggling companies or the issuance of surplus notes, similar to MBIA’s recent offering. MBIA had to sell those notes at an interest rate of 14 percent to attract investors.

Over the past few months, ratings agencies said they were worried bond insurers would not have enough capital to cover potential claims. Bond insurers pay principal and interest on debt when bond issuers are unable to make payments.

Bond insurance claims could rise astronomically in the coming months because of rising delinquencies and defaults among mortgages, especially subprime loans given to customers with poor credit history. As those mortgages increasingly default, bonds backed by the troubled loans could also default, leading to a rise in claims. Ratings agencies say bond insurers might not be able to handle a worst-case scenario.

If a bailout cannot be orchestrated, many bond insurers would likely face ratings downgrades and go into run-off _ a scenario where they book no new business and instead just earn money on current insurance premiums already written.

Goldman Sachs Group Inc. analyst James Fotheringham said Ambac shares would be worth $15 (euro10.23) in a run-off scenario, but $35 (euro23.87) if a bailout occurs. If MBIA were to go into run-off, shares would be worth about $6 (euro4.09), but a bailout could boost the share price to $48 (euro32.74), Fotheringham said. Security Capital would be worthless in run-off, but worth $13 (euro8.87) after a bailout, he added.

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