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Bond insurers reject Buffett's $800B offer

Warren Buffett's offer to help insure municipal bonds assuaged some of the broader market's credit concerns Tuesday, but the troubled bond insurers may have little interest in the offer.
/ Source: The Associated Press

Billionaire investor Warren Buffett's offer to help insure municipal bonds assuaged some of the broader market's credit concerns Tuesday, but the troubled bond insurers may have little interest in extra coverage for their best assets.

Buffett's reinsurance offer wouldn't cover any of the subprime mortgage debt that's much more likely to cause problems for the bond insurers, and Berkshire Hathaway would require a substantial premium for covering the municipal bonds. Credit rating agencies were already worried the insurers won't have enough cash available to cover a potential spike in claims.

Stocks on Wall Street surged after Buffett discussed a few details of his offer to three companies to reinsure about $800 billion of their municipal bonds in an interview on CNBC, but two of the bond insurers have rejected the deal and analysts said it appeared unlikely.

Reinsurance is coverage that insurance companies purchase when they want to completely or partly insure the risk they have assumed for their customers.

"I really don't think this does much for anyone but Warren Buffett," said Kevin Giddis, fixed-income strategist at Morgan Keegan. "The thought of an insurer giving away its best business and their only means of surviving this mess in return for the rest of its 'junk in the trunk' should leave them cold."

Buffett said one of the three bond insurers Berkshire offered reinsurance to had already said no, but he didn't say which of the three companies — Ambac Financial Group Inc., MBIA Inc. or Financial Guaranty Insurance Co. — declined.

Then, Ambac said in a statement late Tuesday that the reinsurance wouldn't be in the best interests of the bond insurer or all of its policyholders.

That made Ambac the second company to reject Berkshire's offer. Ambac spokesman Peter Poillon said his company was not the one Buffett said rejected his offer.

Earlier this month, Buffett said Berkshire would not invest in any of the bond insurers, but his company would consider insuring some of the risks the bond insurers had assumed. And Berkshire launched its own bond insurance business late last year to take advantage of the credit problems other bond insurers have been having, so it's clear Buffett's not motivated by charity.

"When I go to St. Peter I will not present this as some act that will entitle me to get in," Buffett said on CNBC. "We're doing this to make money."

Berkshire spokeswoman Jackie Wilson said Buffett was traveling Tuesday, and no one was immediately available to comment.

Edward J. Grebeck, chief executive of Tempus Advisors, said he doesn't think the bond insurers will want to do this reinsurance deal with Berkshire because municipal bond risk isn't their problem.

"It's good for the policy holders, but bad for management," said Grebeck whose firm consults with hedge funds and private equity firms on credit risk.

Grebeck said the real problem for bond insurers is the structured finance products that now represent about 35 percent of the investments they back. Bond insurers originally offered insurance mainly to municipalities but that has changed in recent years.

Those risky, complex assets, called collateralized debt obligations or CDOs, include subprime mortgage debt given to customers with poor credit history. As those mortgages have increasingly defaulted, ratings agencies fear the CDOs supported by the troubled loans will default as well.

A spike in defaults in the coming months or years could force the insurers to pay billions of dollars in claims.

Some bond insurers, such as Ambac and FGIC, have been downgraded by ratings agencies in the past month as they have been unable or chosen not to raise capital to ensure their vital "AAA" financial strength rating.

Bond insurers essentially need "AAA" ratings to book new business.

Berkshire's new bond insuring division has a "AAA" credit rating. Buffett has said Berkshire's new company, Berkshire Hathaway Assurance Corp., already has done a couple of deals insuring municipal bonds despite being in business for less than two months.

Friedman, Billings, Ramsey & Co. analyst Steve Stelmach wrote in a research note that investors shouldn't consider Berkshire's offer a solution for bond insurers' problems.

If the bond insurers bought the reinsurance from Berkshire, Stelmach said they could still face credit downgrades because the bond insurers would be left with a riskier portfolio. Because they would no longer be insuring the municipal bonds themselves, they would lose some of the profit and remaining premiums associated with them.

"In fact, we believe the offer, if accepted, could ultimately accelerate the process toward a potential run-off for the bond insurers," Stelmach said.

William Schwitter, chairman of the global leverage finance practice at the law firm Paul Hastings, said the bond insurers "need a broader portfolio fix so I'm not surprised" that it has been rejected by at least two companies.

Schwitter said bond insurers likely need to free up more capital than could be available by reinsuring their municipal bond business — a business that is considered the safest portion of their operations. The companies must set aside money to cover possible claims if they insure the bonds themselves.

The Berkshire offer "frees up capital devoted to municipal bond deals for CDOs; from that prospective it's a good thing, but it likely doesn't free up enough," Schwitter said.

But Buffett's offer could provide a starting point for a "multi-piece fix" and buy bond insurers a little more time before ratings agencies act, Schwitter said.

Berkshire owns insurance, furniture, jewelry and candy companies, restaurants, natural gas and corporate jet firms and has major investments in such companies as The Coca-Cola Co. and Wells Fargo & Co.