If this is good, I would sure hate to see what bad looks like

It’s hard not to view the near collapse of AmTrust and Maiden as partly a colossal failure of the various entities tasked with overseeing and safeguarding the industry.

Throughout the firms’ histories, both rating agencies and regulators have constantly turned a blind eye, looked for ways to kick the can down the road, or passed the buck.

Most frustratingly, the companies appear to have been successful in convincing its overseers that all external criticism is the act of some self-motivated “shorts”, a taint that continues to this day despite so much of the short thesis being proved fundamentally correct.

Perhaps the biggest laugh out loud moment of absurdity came last month, when AM Best finally downgraded Maiden following a 75 percent decline in book value over two years.

The big decision? To downgrade the firm from A- to B++.

Maiden, by its own admission, does not currently have even enough capital to meet its minimum margin of solvency or enhanced capital requirement under Bermuda law.

Yet the company’s financial strength is still rated as “Good” with a balance sheet regarded as “strong” by the quasi-monopoly rating agency in the industry.

All I can say is, if this is good, I would sure hate to see what bad looks like.

This is….Well, let’s just say it’s hard to explain AM Best’s forgiving nature without assuming the agency is giving the company a huge amount of forbearance for Maiden’s prospective actions, analyzing the company on a pro-forma basis rather than on an “as-is” basis.

Yet this level of forbearance seems extraordinary, even by AM Best’s own track record of “pretend and extend” for Karfunkel companies. Maiden has huge, huge challenges outstanding in order to get above its capital requirements by year end.

The firm could just about get there if its announced asset sales and run-off transactions complete in time. But none of this should be assumed to be a certainty.

First, it is still not entirely clear how much capital the firm’s asset sales will raise.

Though the company has disclosed around a $300mn estimate, this is subject to closing true-ups.

Enstar is a famously sharp-elbowed negotiator, and given Maiden’s position as a forced seller, it is unlikely to have much leverage to walk away if the terms of the deal begin to sour somewhat.

Second, a huge amount of its capital generated through its recent sale activities could be consumed by debt redemptions triggered by this corporate activity.

The company has already admitted $153mn of the sales proceeds will go to debt redemptions, but the firm has another $110mn of debt with similar terms and conditions that could reasonably face a redemption challenge from holders.

Third, there are serious complications that could either jeopardize or at least delay the closing of the loss portfolio transfer with Enstar.

The details are somewhat complex. The AmTrust-Maiden quota share has an unusual structure that sees an intermediate AmTrust company reinsure the US subs and then retrocedes this out to Maiden. In order for the AmTrust intermediate company to collateralize its obligations, Maiden loans the company money on an unsecured basis.

This leaves a problem for Enstar. Maiden cannot pay the $2.8bn premium that it owes Enstar without recalling its leant assets. Yet doing so would leave the AmTrust subs without collateral for reinsurance.

One way of solving this would be for Enstar to extend its own unsecured loan to Maiden which is then extended to AmTrust. But Enstar is not famed for its generosity, and it is hard to think the company would want to make a huge, risky, unsecured loan to Maiden.

Yet unwinding this structure in order for Enstar to face the US subsidiaries directly could also be problematic, as it would force AmTrust and Maiden to reconcile the different accrued values for their reinsurance relationship which would force a loss on one party that it probably couldn’t bear.

The point of all this is that as things stand today, Maiden is in deep trouble and still staring down the barrel of insolvency. That it has outlined a somewhat credible path to solvency does not make it certain or even highly probable that it will get there.

If Maiden is in trouble, then there should be real concerns about the balance sheet at AmTrust. And ultimately, the regulators should be sweating about the ultimate policyholders’ rights and protections.

There is little evidence of this to date.