MBIA’s capital shortfall

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Its words might sound Delphic but Moody’s is laying down the law. Its comment that bond insurer MBIA is “somewhat likely’’ to face a capital shortfall is a clear threat – raise new capital in short order or risk being put on watch for a downgrade. The implications for MBIA, alongside rival Ambac, of being downgraded from triple A are too big for them to go to the edge of the abyss.

Both should quickly follow in the footsteps of Freddie Mac and Fannie Mae, which have already tapped investors for a combined $13bn. The bond insurers should also raise more than they think is strictly necessary. Their business models already operate on seemingly thin capital cushions. Given housing market uncertainty, they should factor in worst-case scenarios. The last thing they want is to come back for more.

The question is, how easy will it be to raise capital? Freddie raised $6bn in short order. But in spite of all its problems, the company still has a reassuring feel, not least because of its implicit government backing. MBIA and Ambac’s business models already leave many investors scratching their heads. The risk of further impairment to their portfolios of mortgage-backed securities could scare off those who have not done seriously detailed work. The other option of reinsuring a chunk of their portfolios to reduce capital requirements will not be straightforward either.

Both are under the same pressure, there is an incentive to move first. It is not clear how much demand there will be for reinsuring bonds or providing new capital, given the risks. But whichever route to boost capital the bond insurers choose, it is likely to be expensive and equity holders will get hit. If they reinsure bonds, it will hurt future earnings. If they raise capital it will dilute investors upfront. On top of that, dividends pay-outs look unlikely to emerge unscathed.

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