Behind Buffett's Bond Gambit

The Berkshire Hathaway chief's offer to reinsure $800 billion in munis may signal a move to dominate the bond insurance biz

by David Bogoslaw

The role of the white knight who swoops in to rescue a business in distress is one that Warren Buffett plays well, and he's profited nicely from it in the past. Remember his bailout of Salomon Brothers in the early 1990s? But the financial guaranty outfits whose municipal-bond liabilities the billionaire investor offered to take over last week may not wish to take part in Buffett's latest performance.

In an interview on CNBC Business News on Feb. 12, Buffett said that in the prior week his company Berkshire Hathaway (BRKA) had offered to reinsure about $800 billion worth of tax-exempt municipal bonds insured by three leading financial guaranty firms, which would allow them to preserve their coveted triple-A ratings. He would also put $5 billion of capital into his new bond insurance company, Berkshire Hathaway Assurance, to provide it with the wherewithal to cover the assumed liabilities.

At-Risk Insurers Might Say No

Buffett's move comes at a particularly anxious time for the bond insurance industry. The three companies to whom Buffett made the offer—MBIA (MBI), Ambac Financial Group (ABK), and privately held Financial Guaranty Insurance (FGIC)—have been doggedly trying to secure capital infusions from investment banks, private equity firms, and other sources, to help them preserve their triple-A ratings, a requirement if they hope to attract new business. The insurers face the prospect of going under if they can't raise ample cash to cover all the claims that would result if the asset-backed securities that they have insured—including collateralized debt obligations—should default.

Shares of MBIA and Ambac fell more than 15% on Feb. 12.

Buffett is giving the bond insurers 30 days to shop around for a better offer, but he told CNBC that one of the companies has already rejected his bid.

Market observers presume that MBIA has already turned down Buffett's offer, as the company has a commitment from Warburg Pincus to buy $1 billion in convertible preferred stock and last week issued $1 billion in new common stock.

And MBIA may not be the only one to rebuff Buffett. "I'm not sure any of them will take this offer because it's not clear to me that it's that beneficial either from a rating agency perspective and certainly from a financial perspective," says Gary Ransom, an equity analyst at Fox-Pitt Kelton in West Hartford, Conn. "The scales are tipped steeply toward Buffett," he says. (Fox-Pitt or its affiliates may seek compensation for investment banking services from Berkshire Hathaway during the next three months.)

Buffett Presses His Advantage

The reason for going public with his offer was probably the hope of getting the ratings agencies and regulators to put pressure on the bond insurers to accept the deal, says Whitney Tilson, managing partner at T2 Partners, a hedge fund manager in New York.

Buffett has made it very clear that there's nothing altruistic about his offer. He stands to make a lot of money by assuming these policies, given that the cities and towns that issue munis hardly ever default on their debt. When they do, the recovery rate is more than 90%, compared with a 50% recovery rate in corporate debt defaults, says Tilson.

Buffett has long had his eye on the muni-bond insurance business and in December announced he was starting Berkshire Hathaway Assurance.