Download The State of Financial Guaranty Insurance

Finance 431:
Property-Liability Insurance
Lecture :
Financial Guaranty Insurance
Overview
•
•
•
•
Financial Guaranty Insurance
Sub-Prime Crisis
The Effect on Financial Guaranty Insurers
Other Effects on the Insurance Industry
Financial Guaranty Insurance
Definition: Insurance on a bond or other security
which guarantees that interest and principal will
be paid on time and in full in the event of default.
Default – when the issuer of the bond or security does not
pay the principal and interest for the bond or security.
Also known as Bond Insurance
Financial Strength
Financial strength is key due to the insurers
obligation to pay the principal and interest if
default occurs.
– Rating Agencies
• AAA, Aaa ratings from S&P, Fitch, and Moody’s are needed
in order for financial guaranty insurance companies to be
able to continue writing coverage and stay in business.
• High ratings for the financial guaranty companies leads to
high ratings for bonds and securities insured by these
companies.
– Claims-Paying Ability
– Reinsurance
Products of Financial Guaranty
Insurance
• Asset-Backed Securities
• Municipal Bonds
• International Securities
– Includes securities from asset-backed
markets and infrastructure finance markets
from around the world.
Asset-Backed Securities
• The combination of similar assets and their cash
flows to form securities that have interest
payments and a principal.
• Examples:
–
–
–
–
–
Mortgage Backed Securities (MBSs)
Student Loan Securities
Credit Card Receivable Securities
Car Loan Securities
Collateralized Debt Obligations (CDOs)
• The combination of several asset-backed securities.
Municipal Bonds
• A bond issued by states, cities, local
governments, or public agencies.
• Bonds fund public projects, and they fund private
projects as long as they serve public needs.
• Interest income from funding of public projects is
tax exempt from federal taxes, as well as state
and local taxes for most projects in most states.
• Examples of projects:
– Schools
– Highways and roads
– Utilities
Who Benefits from Insurance?
• Asset-Backed Issuers
– Higher ratings on bonds and securities allow for lower interest
payments and thus lower borrowing costs to issuers.
• Municipal Issuers
– Higher ratings leads to a decrease in financing costs.
– Small municipal issuers receive ratings of bond insurer instead
of having to file for expensive agency ratings.
– Helps marketability of lesser known issuers: local town agency.
• Taxpayers
– Tax-exempt features on municipal bonds saves a lot of money
for taxpayers.
• Investors
– Guaranteed to receive interest payments and principal in the
event of the issuer defaulting.
Industry
• Association of Financial Guaranty Insurers (AFGI)
– Most financial guaranty insurers are members
– Members:
•
•
•
•
•
•
•
•
•
•
•
ACA Financial Guaranty Corp.
Ambac Assurance Corporation
Assured Guaranty Corp.
BluePoint Re Limited
CIFG
Financial Guaranty Insurance Company
Financial Security Assurance
PMI Guaranty Co.
Radian Asset Assurance Inc.
RAM Reinsurance Company
XL Capital Assurance
• Monoline Industry
Which financial guaranty insurance products
have tax free interest income?
A)
B)
C)
D)
E)
Asset-Backed Securities
International Securities
Mortgage Backed Securities
Municipal Bonds
None of the above
Student Loans would fall under which
financial guaranty insurance product?
A)
B)
C)
D)
E)
Asset-Backed Securities
Mortgage-Backed Securities
Municipal Bonds
International Securities
None of the above
Sub-Prime Market
• Sub-prime loans
• Sub-prime mortgages
– Loans or mortgages given to borrowers with
low credit ratings.
– These loans or mortgages have higher
interest payments due to the increased risk of
the borrowers defaulting.
Sub-Prime Crisis
• Housing market begins to boom in 2002 due to low
interest rates.
• Asset-backed securities on mortgages are created also
known as mortgage backed securities (MBSs). At first
with normal mortgages.
• As housing boom continues after 2002, new assetbacked securities are created, but these new securities
included sub-prime mortgages.
• Some of these securities with very few sub-prime
mortgages bundled together with other normal
mortgages were able to earn AAA ratings.
Sub-Prime Crisis
• Other securities with many sub-prime mortgages
bundled with other normal mortgages were still able to
receive investment grade ratings of A or higher. This
was because of the MBSs being a bundle of many subprime mortgages, the rating agencies figured the chance
of the majority of sub-prime mortgages defaulting was
minuscule due to the booming housing market.
• Additionally, financial guaranty insurance companies
insured many of these MBSs, which led to higher ratings.
Sub-Prime Crisis
• The housing market continued to boom and this led to
soaring profits for all parties involved including investors,
brokers, banks, rating agencies, and bond insurers.
• Due to the MBSs being so lucrative, CDOs began to
appear. These packaged medium to low rated MBSs,
which included mainly sub-prime mortgages, together to
form CDOs that were able to receive AAA ratings for the
same reason the other MBSs were able to receive AAA
ratings in the first place.
Sub-Prime Crisis
• Since the mortgages were being turned in to ABSs, this
allowed the mortgage lenders to transfer much of the
default risk to the investment market.
• With mortgage lenders not carrying a lot of the default
risk, they began to alter their loans to get even more
people to purchase houses.
• These new loans included even lower interest rates for
the first or second year of mortgages, or they included
interest only mortgage loans, in which borrowers would
not have to pay the larger principals until a few years
passed.
Sub-Prime Crisis
• Many home buyers who could not normally afford
houses borrowed from these new mortgage loans in
order to purchase a home.
• The rationality of purchasing houses with the newer
mortgage loan plans was that the housing market would
continue to boom. In this scenario the purchased homes
would increase in value substantially enough to be able
to refinance the home at a profit, and thus be able to
afford the higher future payments of the mortgage.
• These new mortgages were mainly sub-prime mortgages
and they were being made into MBSs and CDOs as well.
Sub-Prime Crisis
• With all of these different asset-backed securities trading
on the market, and profits soaring for the main players in
these transactions, most people thought that the housing
market would continue to boom.
• However, this was not the case. By the middle of 2006
home sales stalled and the value of houses stopped
climbing. By 2007 many homes’ values began to drop.
• With housing values decreasing, many new sub-prime
home owners could no longer afford their houses by
refinancing, and this led many of these home owners to
default on their mortgages.
Sub-Prime Crisis
• Now the housing market began to falter even more, and this led
to even more defaults for homeowners who did not want to invest
in a home that was losing value.
• With homeowners defaulting on their mortgages, all these MBSs
and CDOs based on receiving mortgage payments from subprime mortgages defaulted as well.
• With the ABSs defaulting the investment market that dealt with
these ABSs and all the players involved began to lose a lot of
money.
• These recent events continue to hurt the housing market.
Housing prices continue to drop, and people who want to
currently buy houses who need loans are having trouble finding
good deals.
• This all leads to even more defaults on mortgages today causing
even more defaults on ABSs, which in turn is causing further
losses to the investment market, thus the sub-prime crisis.
Sub-Prime Crisis
Sub-Prime Crisis
Sub-Prime Crisis
In your opinion who is most at fault for the
sub-prime crisis?
A)
B)
C)
D)
E)
Mortgage Lenders
Investors
Home buyers
Rating Agencies
Bond Insurers
Impact on Financial Guaranty
Insurance Companies
•
•
•
•
•
•
•
•
Financial Losses
Rating Cuts
Little to no new business
Companies asking to not be rated by certain
rating agencies
AFGI loses a member
New financial guaranty insurance company
New bond insurance market leaders
Potential regulation changes
Financial Losses
• Two market leading companies had big losses
each reporting multibillion dollar fourth quarter
net losses.
– MBIA Insurance Corp.
• Net losses of $2.3 billion.
• $3.4 billion write down due to sub-prime loans crisis.
• Predicted losses from sub-prime crisis total $11.6 billion.
– Ambac Assurance Corporation
• Net losses of $3.2556 billion.
• $5.21 billion write down due to sub-prime loans crisis.
• ACA had third quarter losses of $1 billion.
• PMI Group reported a fourth quarter loss of $236 million
due to its U.S. mortgage insurance operations.
• Other companies suffered or will suffer significant losses
as well, this can be seen from rating cuts.
Rating Cuts
• ACA Financial Guaranty Corp.
– S&P cuts rating from A to CCC
• Ambac Assurance Corporation
– Rating cuts by Fitch from AAA to AA with outlook negative. S&P
and Moody’s remain AAA/Aaa with outlook negative.
• Assured Guaranty Corp.
– Fitch, S&P, and Moody’s all remain AAA/Aaa with stable outlook.
• CIFG
– Fitch cuts rating from AAA to AA- to A- with outlook negative.
S&P cuts rating from AAA to A+ with outlook negative.
Moody’s cuts rating from Aaa to A1 with outlook stable.
• MBIA Insurance Corp.
– Fitch cuts ratings from AAA to AA with negative outlook. Moody’s
and S&P remain Aaa/AAA with negative outlook.
Rating Cuts
• Financial Guaranty Insurance Company
– Fitch cuts ratings from AAA to AA to BBB with outlook negative.
S&P cuts ratings from AAA to AA to A to BB with outlook negative.
Moody’s cuts ratings from Aaa to A3 to Baa3, rating still under
review for further downgrade.
• Financial Security Assurance
– Fitch, S&P, and Moody’s all remain AAA/Aaa with stable outlook.
• Radian Asset Assurance Inc.
– S&P rating of AA with stable outlook. Moody’s rating of Aa3 with
outlook negative. Fitch changes rating from AA to A+.
• XL Capital Assurance
– Fitch cuts ratings from AAA to A to BB. S&P cuts ratings from AAA
to A-. Moody’s cuts ratings from AAA to A3, rating still under
review for further downgrade.
• PMI Guaranty Co.
– S&P rating of A+, Moody’s rating of Aa3, and Fitch rating of AA.
Rating Cuts
• Mortgage Guaranty Insurance Corporation (MGIC)
– S&P rating of A, Moody’s rating of Aa2, and Fitch rating of AA.
• RAM Reinsurance Company
– S&P rating of AAA, with negative outlook. Moody’s rating of Aa3
with negative outlook.
• BluePoint Re Limited
– S&P rating of AA, and Moody’s rating of Aa3.
• Channel Reinsurance Ltd.
– Moody’s cut rating from Aaa to Aa3
• Assured Guaranty Re Ltd.
– S&P and Fitch ratings of AA, and Moody’s rating of Aa2
• CMG Mortgage Insurance Company
– S&P rating of AA-, and Fitch rating of AA
Slowing of Business
• Insured municipal bond issuance decreased by
about half in the first quarter of 2008.
• The issuance of insured debt in the first quarter
from last year to this year fell from $55.1 billion
to $21.7 billion.
• Ambac Assurance Corporation’s first quarter
market share dropped from 24.7% a year a go to
1% this year.
• MBIA Insurance Corp. first quarter market share
went from 19.4% a year ago to 2.1% this year.
• Financial Guaranty Insurance Company did not
insure any new municipal bonds during the first
quarter of 2008.
Withdrawals
• MBIA Insurance Corp. withdrew from the
Association of Financial Guaranty Insurers
(AFGI) on February 21, 2008 due to
disagreement on the future of bond insurance.
– MBIA believes the industry should split the insuring of
municipal bonds apart from the insuring of the often
riskier asset-backed securities.
• CIFG has asked Fitch ratings to withdraw its
ratings on the company due to belief the credit
agency has a poor rating approach.
New Company
• Warren Buffet creates a new municipal
bond insurance company.
– Berkshire Hathaway Assurance Corporation
• Began insuring municipal bonds in
December 2007
• Recently earned its first financial strength
rating from S&P with a rating of AAA.
• Although Moody’s has not rated the
company yet, they are rating municipal
bonds insured by the company with Aaa
ratings.
Emergence of Market Leaders
• Financial Security Assurance
– Doubled its market share to 52.7% in the first
quarter
• Assured Guaranty Corp.
– Increased its first quarter market share to 25.9%
this year from 1% a year ago.
• Berkshire Hathaway Assurance Corporation
• All these companies have AAA ratings.
Potential Changes
• Future Regulation Changes For Bond Insurers
– May not be allowed to insure bonds or securities
pass a certain risk level.
• Future Regulation Changes For Rating System
– May employ independent analyzers to assess the
risk for the bond insurers.
• Ending Municipal Bond Insurance
Other Problems Created
• Rating cuts on financial guaranty companies has
caused rating cuts on currently insured bonds.
• This has caused interest rates to increase.
• Several municipal issuers now cannot afford to
pay the significantly higher interest payments,
and they may default, causing further losses to
the bond insurers.
– Example
• Alabama’s Jefferson County’s Sewer Bond Crisis
Impact on Insurance Industry
• Private Mortgage Insurance (PMI)
• Investment Portfolios
– Very little to do with investing in sub-prime ABSs, but
more with ripple effect on declining stock market.
•
•
•
•
•
BPP Insurance
Workers Compensation
D&O Insurance
Surety Insurance
Sales Decline
– Due to sluggish market and building sector.