Bond Insurance "No Good" with Buffett EntryThis is an extremely important development. This will cause the next downleg in U.S. bank stocks (CM will be more moderately impacted).
This has a lot to do with bond insurance. CM has $9.3B of "hedged" exposure to CDOs. But that hedge is based on insurance from guys like ACA, MBIA and AMBAC.
ACA is a penny stock that supposedly insurtes over $35B of exposure and is under supervision from regulators. CM will likely need a $2B writedown on $3.5B of its exposure.
Howeverm the balance of CM's exposure is with so-called AAA insurers. But that rating is fictitious. Look at the share prices of MBIA and AMBAC. MBI is down $3.00 today. More importantly, bonds issued by MBIA is more like junk than "AAA". The ratings are a joke!
Now that Buffett is entering the business will be the beginning of the end for the so-called "AAA" guys. That's because Buffett can concentrate only in municipals where the risk profile is normal and manageable. If one municipality defaults it typically has no bearing to other municipalities. But if a tranche of CDO goes bad other CDOs would look roughly the same - so if they go bad they all go bad at once.
Its a matter of weeks before Fitch downgrades the top two players. S&P and Moodys will need to follow. The fact all three have AAA ratings is almost downright fraudulent. The rating agencies need to be investigated themselves. I wish law firms launch class-action lawsuits and get this thing cleaned-up.
Reuters
Buffett starts up bond insurer to rival MBIA, Ambac
Friday December 28, 11:23 am ET
By Jonathan Stempel
NEW YORK (Reuters) - Warren Buffett's Berkshire Hathaway Inc (NYSE:BRK-A - News; NYSE:BRK-B - News) is starting a bond insurer that would help state and local governments lower their borrowing costs, posing a direct challenge to established rivals struggling with deteriorating credit markets.
The new insurer, Berkshire Hathaway Assurance Corp., should receive a license to operate from New York State's insurance department by Monday, department spokesman Andrew Mais said.
Buffett's entry puts pressure on MBIA Inc (NYSE:MBI - News) and Ambac Financial Group Inc (NYSE:ABK - News), the largest bond insurers. Credit rating agencies are reviewing their ratings on concern they won't be able to cover losses on bonds they guarantee.
The Berkshire unit is expected to win a "triple-A" credit rating, according to the Wall Street Journal, which reported the unit's creation. Buffett told the newspaper he will try to expand the unit into California, Florida, Illinois, Texas and Puerto Rico.
"Berkshire provides the municipal finance industry with a lifeline," said Sean Egan, head of the ratings desk at Egan-Jones Ratings Co in Philadelphia.
"The industry will be able to turn to a truly triple-A credit," Egan said. "It also significantly increases pressure on MBIA and Ambac. Many investors are likely to demand that bonds are backed by Berkshire."
Berkshire, MBIA and Ambac did not immediately return requests for comment.
In morning trading, MBIA shares fell $3.00, or 13.5 percent, to $19.27, while Ambac fell $3.91, or 13.4 percent, to $25.23. Through Thursday, the respective shares had fallen 70 percent and 67 percent this year. Berkshire's Class A shares rose $1,900 to $139,700 in morning trading.
Separately, Omaha, Nebraska-based Berkshire agreed to buy the NRG NV reinsurance unit of ING Group NV (Amsterdam:ING.AS - News; NYSE:ING - News) for about 300 million euros ($441 million), the Dutch bank said. That purchase is expected to close in the first half of 2008.
RIVALS FACE PRESSURE
Municipal issuers finance such things as hospitals, road construction, schools, sewer systems and sports facilities.
They often seek bond insurance to reduce the perceived risk of owning their debt. That can attract more investors, resulting in lower borrowing costs and saving taxpayers money.
"We can't guarantee everything, and we will not take risk beyond what's prudent for us," Buffett said in an interview with the Journal.
He said he capitalized the new business at $105 million and will commit "quite a bit of capital if we like the business," but maintain "a capital ratio that's stronger than anybody's."
Berkshire owns more than 70 businesses, including auto insurer Geico Corp and reinsurer General Re Corp. It said it ended September with $47.08 billion of cash.
Fitch Ratings last week said MBIA and Ambac may lose their triple-A credit ratings, after the former shocked investors by revealing it had guaranteed $8.1 billion of particularly risky mortgage debt.
A smaller bond insurer, ACA Capital Holdings Inc (ACA - News) is struggling for survival after last week giving control of much of its business to Maryland regulators.
"Having new entrants in the market ... is a very positive development," New York State Insurance Superintendent Eric Dinallo said in a statement. "That is why the (insurance) department expedited the licensing."
Ajit Jain, who runs much of Berkshire's insurance operations, will run the new Berkshire unit, the Journal said. Analysts consider Jain one of the top candidates to eventually replace Buffett, 77, at the helm of Berkshire.
CHARGING MORE
Buffett told the Journal the new unit will charge more than competitors because of the "moral hazard" that issuers might take advantage of the insurance to borrow too much. This would saddle insurers with a greater risk of default.
"If you're an issuer, you might pay more for Berkshire, because investors will be more comfortable they will be repaid if something happens," said Rob Haines, senior insurance analyst at CreditSights Inc.
Buffett, often called the world's greatest investor, is known for taking large business and investment risks.
He has said, for example, that Berkshire is willing to suffer a $6 billion insurance loss on a single storm. The company was able to boost premiums after Hurricane Katrina after weaker rivals reduced underwriting risk.
Meanwhile, Berkshire's common stock portfolio is no model of diversity. It includes some $36 billion invested in just four stocks, based on reported shares held: American Express Co (NYSE:AXP - News), Coca-Cola Co (NYSE:KO - News), Procter & Gamble Co (NYSE:PG - News) and Wells Fargo & Co (NYSE:WFC - News).
Buffett said the new insurance unit will avoid investing in structured products, including bonds backed by assets such as mortgages and credit-card receipts.
"Berkshire will be a formidable competitor, and take market share," Haines said. "Its entry is a big vote of confidence in the bond insurance business. It suggests the business remains viable, even with the problems MBIA and Ambac have had."