Silverstreet sees opportunity in bond insurer woes

LONDON (Reuters) - The perilous state of U.S. bond insurers, facing possible ratings downgrades, writedowns and potential sizeable losses, offers plenty of opportunities for hedge funds to make money, according to SilverStreet Capital.

Gary Vaughan-Smith, chief executive at London-based fund of hedge funds SilverStreet, told Reuters that banks and insurance regulators should be focusing on the possibility that bond insurers will fail, rather than a possible downgrade by ratings agencies.

Hedge fund Pershing Square Capital Management claimed in a letter on Wednesday that bond insurers Ambac (ABK.N) and MBIA (MBI.N) face combined losses topping $23 billion from bonds they insured.

William Ackman of Pershing, which has shorted bond insurers' shares, said in November last year that MBIA could become insolvent, a charge the insurer has repeatedly rejected.

MBIA on Thursday said Pershing's model contains "extreme assumptions", and that it was "virtually impossible" to imagine becoming insolvent.

"If Pershing Square's figures are near the truth, it will be more of a solvency issue," Vaughan-Smith said in an interview. "The markets are in line with the Pershing view.

"No doubt they (Pershing) are talking their position -- they've been short for a few years. But some of the assumptions they used were quite conservative."

Bond insurers, also known as "monolines", guarantee timely interest and principal payments on bonds and sell protection on structured deals.

Credit ratings agencies, which view bond insurers' capital as insufficient due to the meltdown in subprime mortgages, have put their top-notch triple-A-ratings on review for possible downgrades, a move that has sent shockwaves around global financial markets.

Vaughan-Smith said it may eventually be cheaper for banks to buy bond insurers than to let them fail.

"The monolines are too big to fail. They collectively insure $2.5-$3.5 trillion of bonds. If MBIA and Ambac go into Chapter 11 (bankruptcy protection), it's a fairly catastrophic event.

"Ultimately banks will have to run the numbers -- what does it cost if monolines go into Chapter 11 and what does it cost if we have to inject equity?"

On Friday, CNBC reported eight banks have formed a consortium to seek a rescue plan for MBIA, Ambac Financial Group and other troubled bond insurers.

MORE BALANCED WORLD

However, hedge fund managers on top of the situation and with good stockpicking ability should do well in this environment.

"It's a nice long-short environment ... In the last few years the way to make money in credit has been by being long. It's now changed to a more balanced world.

"We see good quality opportunities now ... The key is manager selection, having managers who are good at shorting."

Shorting means betting on a lower price for a security in the future.

Vaughan-Smith also said he is positive on macro strategies and convertible arbitrage.

"Macro tends to do better in periods of dislocation, for instance when the Fed is forced to cut rates faster than expected ... Convertible arbitrage has been a poor performer in recent years, but convertibles have cheapened with other bonds."

SilverStreet manages around $700 million in assets.