Each day brings word of new chaos in the financial world. Interestingly, while many observers, including me, were focusing on what we believed would be the first-order effects of credit problems at the bond insurers (e.g., forced selling of securities by institutions who could only hold instruments with a certain minimum credit rating), the second-order effects are already being felt, too. In "Bond Insurance Turns Toxic for Munis as Rates Soar," Bloomberg's Martin Z. Braun details the latest.
Bond insurance sold by MBIA Inc., Ambac Financial Group Inc. and Security Capital Assurance Ltd. is backfiring on counties, universities and hospitals across the U.S., more than doubling some borrowing costs.
Park Nicollet Health Services in Minneapolis may pay an extra $5 million to $6 million this year, about a quarter of its operating profit, because interest on $375 million in floating- rate debt doubled in the last six weeks, said Chief Financial Officer David Cooke. The rate on $98 million insured by Ambac climbed to 6 percent on Jan. 30 from 3.06 percent on Jan. 2.
"We'll have to reduce our capital expenditure program, which means less equipment, less modernization of facilities," Cooke said in an interview. The hospital paid Ambac to "count on that AAA insurance for 30 years. Now it's going away on us."
Investors are shunning insured bonds after three of the biggest guarantors, owned by Ambac, Security Capital and FGIC Corp., were stripped of at least one AAA credit rating amid losses on debt tied to subprime mortgages. Interest costs on floating-rate bonds sold by more than 100 governments, hospitals and colleges rose as much as 7 percentage points since the beginning of January even as the Federal Reserve lowered its benchmark rate for U.S. borrowing by 1.25 percentage points.
'State of Turmoil'
Park Nicollet is among tax-exempt borrowers seeking to restructure their debt to supplement or strip out the insurance that was supposed to reassure investors and lower their costs. The Bay Area Toll Authority in Oakland, California, and the Billings Clinic in Billings, Montana, shelved plans to borrow.
"The market's in a state of turmoil," said Bryan Mayhew, chief financial officer for the toll authority, which manages the San Francisco Bay Bridge and six other state-owned toll bridges.
Tax-exempt money-market funds can't hold debt rated lower than AA-, and downgrades to insurers are enough in some instances to make the bonds it backs ineligible.
State and local government debt is tainted even though Moody's Investors Service says the default rate on municipal bonds is 0.1 percent.
Insurers are losing the top ratings because of the structured securities they began guaranteeing decades after they first offered protection against municipal defaults. The toxin is debt tied to subprime mortgage borrowers; a surge in delinquencies has triggered about $146 billion in writedowns and losses at banks and securities firms since the start of 2007.
Credit Downgrades
New York-based Ambac is the second-biggest bond insurer after Armonk, New York-based MBIA, while FGIC and Security Capital are fourth and sixth, respectively. The four guarantee about $1.1 trillion of fixed- and floating-rate municipal bonds, or 42 percent of the outstanding state and local government debt, according to data compiled by Bloomberg.
Fitch Ratings downgraded the financial strength ranking of Ambac's main insurance units two levels to AA Jan. 18, and the primary subsidiaries of New York-based FGIC were cut to AA at both Fitch and Standard & Poor's later in the month.
Units of Bermuda-based Security Capital, started by XL Capital Ltd., were dropped by Fitch five grades to A on Jan. 24 and downgraded by Moody's six levels to A3 on Feb. 7. The three rating companies have MBIA's subsidiaries under review for possible cuts and say there may be more downgrades for the others. Financial strength ratings gauge an insurer's claims- paying ability.
Exploring Alternatives
Michael Gormley, a spokesman for Security Capital's XL Capital Assurance Inc., said officials are "sympathetic" to the difficulties facing issuers that insured variable-rate bonds with the company. "We are exploring different alternatives with our clients to address the issues they face due to the currently volatile market," Gormley said in an e-mailed statement.
Ambac spokesman Peter Poillon declined to comment. MBIA spokesman Michael Sitrick didn't return a phone call and e-mail. FGIC's Brian Moore didn't either.
Governments and nonprofits that didn't insure their variable-rate debt are benefiting from five months of Fed easing. The Securities Industry and Financial Markets Association rate, the benchmark for tax-exempt, floating-rate debt, dropped about 2 percentage points to 1.73 percent since Sept. 18 as the Fed's target rate for overnight loans between banks fell 2.25 points to 3 percent.
Lower Rates
The University of Pittsburgh Medical Center, a Pittsburgh- based network of hospitals, in March 2004 issued uninsured floating-rate bonds with a AA- rating, two grades above Park Nicollet. The rate on $80 million of its seven-day debt was reset at 1.68 percent on Feb. 6, down from 3.42 percent on Dec. 26.
Interest costs on insured variable-rate debt are rising as investors invoke their right to sell the debt back. Issuers enter into so-called standby purchase agreements with banks to ensure there are funds available to buy it.
Cooke said he may replace Park Nicollet's standby purchase agreement with a bank letter of credit, which offers more protection to investors because it guarantees the payment of principal and interest and provides an unconditional agreement to buy tendered debt.
For insured auction-rate securities, which are due in 30 years or more, the increases are even more pronounced. The rates are reset by periodic bidding, and investors are concerned that the dealers who hold the auctions may not support the market with their own offers, as they have in the past.
Auctions Fail
On Jan. 22, the first trading session after the Ambac downgrade, two auctions run by Lehman Brothers Holdings Inc. failed, triggering automatic resets at the maximum proscribed in the bond terms. Debt issued by electric utility Nevada Power reset at 6.757 percent, up from 6 percent, while Georgetown University debt went to 6.604 percent from 5.25 percent. Since then, rates on both issues fell after successful auctions.
Kerrie Cohen, a spokeswoman for New York-based Lehman, didn't return a phone call seeking comment.
Rates on $40 million of Worcester Polytechnic Institute's XL Capital Assurance-insured auction-rate securities rose to as much as 6.25 percent on Jan. 22 from 3.9 percent at the beginning of the year. The bonds are rated A+ without insurance.
Tufts University in Medford, Massachusetts, rated one step higher than Worcester at AA-, is currently paying 4.5 percent on $93 million of uninsured auction-rate debt.
"It's frustrating, there's no doubt about it," said Jeffrey Solomon, finance chief of the 3,800-student school in Worcester, Massachusetts. He's is in the process of converting the debt to a new variable-rate bond backed by a letter of credit from Portland, Maine-based TD Banknorth Inc.
Learning to Swim
In Jefferson County, Alabama, the rate on $221.3 million of auction-rate sewer bonds issued in 2002 and insured by XL Capital Assurance soared to 10 percent on Feb. 6 from 3.06 percent on Jan. 9.
Jay Wenger, who advises local governments for Susquehanna Group Advisors Inc., in Harrisburg, Pennsylvania, spends much of his time trying to help clients who want to restructure their variable-rate debt.
"The last few weeks have been difficult to operate in," Wenger said. "There's a whole market out there that's facing a liquidity crisis, that's learning how to swim."
Dipshit Wall Street types have been loading up on munis. Great value they say. Oh really? The last time we had a housing downturn like this we had 4,000 muny bond defaults. Even if we only had fifty or one hundred or one thousand, the risks are there. Wall Street is not only criminal, it's f**king incompetent beyond description.
Posted by: B | February 12, 2008 at 03:01 PM
So how then does Buffett's proposal today figure into things? Of course he's cherry picking:
http://blogs.wsj.com/deals/2008/02/12/a-buffett-in-sheeps-clothing/
And this could leave Ambac et. al. for dead.
However the net social benefit (considering the wide range of borrowers as described above) would in fact (imo) be positive.
(however, in the longer term, to have one company dominate the monoline business is problematic).
Of course this would make BRK.A/B richer than Croesus (whereas now they're only as rich as Croesus).
What's the current state of BRK's Lloyds of London bet. First save that (and make money) and now even bigger game.
pat
Posted by: patfla | February 12, 2008 at 04:06 PM