Friday, August 1, 2008

The monolines rally

Ambac (ABK 3.79) and MBIA Inc. (MBI 7.67) rallied as the shorts are re-assessing the viability of the monolines. SCA, which was left for dead, is now viable, and the other stocks report next week. The banks realized that you can't force these companies into a run-off mode, and it's better to take a hair cut now on their contracts, as the future is too uncertain, especially when the Insurance commissioners want these companies to remain solvent.

If the banks want to press their bet, the feeling is that the insurance for the muni bonds is more important than credit default swaps entered with banks. Furthermore, who is to say the banks don't have dirty hands on the swaps they entered into? What was misrepresented, and when?

Here's some highlights on the latest article in Bloomberg. The only thing we can say with certainty, is that we should have one heck of a short covering rally next week.

And it will probably get vicious!

Aug. 1 (Bloomberg) -- Merrill Lynch & Co.'s agreement to tear up bond insurance contracts sold by Security Capital Assurance Ltd. may provide a template for Wall Street, Bank of America Corp. analysts said.

SCA will pay Merrill $500 million to cancel $3.7 billion of the guarantees it provided on collateralized debt obligations, the analysts wrote. Both companies said they were discussing ways of terminating guarantees with other counterparties when the transaction was announced July 28.

Banks will also be able to liquidate or sell CDOs more easily if insurers have no claim on them, the report said.

Securities firms bought credit-default swaps on the bond insurers that have increased in value. ``Monetization of these gains, we feel, would follow,'' according to the analysts.

Another incentive for the securities firms to accept some payment now is regulators will probably seize the insurers and pay the holders of municipal bonds they guaranteed before the banks, the analysts wrote.

And in the WSJ:

While the terminations of CDO guarantees appears to be positive for many bond insurers, it could spark a rush by financial institutions to get as much capital as they can from the insurers.

If the insurers make significant payouts now "there could be less protection left for the rest of their policyholders," which include investors that hold municipal bond guarantees, said Rob Haines, an analyst at CreditSights.

"This is one of the most complex prisoner's dilemmas I've ever seen," said Eric Dinallo, commissioner of the New York State Insurance Department who helped broker the SCA-Merrill agreement.

Banks that settle contracts with the insurers earlier will "get the benefit of capital certainty" and also avoid problems down the road if any insurers become insolvent, he said.

Mr. Dinallo said his department is "trying to make the banks aware that getting the last penny out of the [insurers] now may not be the best idea; it could potentially crater the deal" or push some firms over the brink into insolvency.

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