Bond Issuers Face New Costs In Insurance Crisis

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With four bond insurance companies facing the potential loss of their triple-A financial strength credit ratings, the effects are bound to ripple through not only banks but bond issuers.

In the $2.6 trillion municipal bond market alone, the debt downgrades threaten some 563,000 individual ratings on municipal issues backed by bond insurance, according to Moody's Investor Service. About half of municipal bonds are backed by insurance, Moody's says, though some of the underlying bonds carry their own ratings and often those are at least single- or double-A.

But downgrades to the bond insurers, including the two biggest, Ambac Financial Group (nyse: ABK - news - people ) and MBIA (nyse: MBE - news - people ), could trigger downgrades of municipal bonds, especially those without underlying ratings. Late Friday the dominoes were set in motion after Fitch downgraded Ambac's financial strength rating to double-A from triple-A, and it downgraded 420 classes of asset-backed securities transactions backed by insurance provided by an Ambac subsidiary.

The uncertain fate of the bond insurers means municipal issuers may have to look elsewhere to guarantee their debt offerings, a requirement of some bond mutual funds. That doesn't mean municipal issuance will drop off. "No one is predicting a significant decline," says Gail Sussman, managing director of public finance at Moody's. "But the landscape will continue to be in flux for a while."

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There is plenty of finger-pointing. Bond insurers began life in the 1970s backing plain old government and corporate bonds. In the last few years, they jumped into the world of structured finance and the complex credit derivatives are getting them into trouble now.

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The significant leverage with which the bond insurers operate has been a big source of controversy, though the ratings agencies haven't acted until recently. "The perfect storm took time to brew, but it hit hard and fast when it came--much harder and faster than we expected," says Banc of America Securities analyst Tamara Kravec, who cut the group to "neutral" from "overweight" on Friday.

Rob Haines from CreditSights had a dimmer view of the situation in mid-December, when the ratings agencies first put the so-called monolines on review. "It has been clear for some time now that the industry as a whole simply does not hold sufficient capital to absorb a fat tail structured default event," Haines wrote then. "Although the markets had come to this consensus several months ago, the agencies chose to wait until the week before Christmas to finally capitulate."

Forbes

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1. Coming Week: Upside Down

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If the bond insurers fail, that raises the specter of a massive wave of wealth destruction in a global financial system that is flooded with illiquid and opaque derivative securities of which there is little understanding, except that their value is connected to credit ratings on structured finance securities.

"This is going to be worse than anybody thinks," says Marta. "What I heard from Ambac {on Friday} is that they're throwing back the lifeline and saying, 'We're not going to make it.' On a fixed income trading floor, that means the world truly is upside down."

On Friday, Ambac said it was abandoning its plans to raise $1 billion, a day after Moody's Investor's Service threatened a credit downgrade. Fitch responded by cutting the premium triple-A rating to double-A for Ambac Assurance Corp., Ambac Assurance UK Ltd. and Connie Lee Insurance Co. and slashing holding company Ambac Financial Group from double-A to single-A. Fitch also warned that more downgrades could be in store.

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Dr. A. Gary Shilling has been a respected Wall Street maven since 1963.
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"Next week, we'll be waiting for not just the next shoe but many more shoes to drop," he says. "That's the bottom line here. The subprime slime was the first to go because those are loans to the least credit-worthy borrowers -- the most vulnerable. But you had plenty of speculation in commercial real estate, emerging market debt and equities, commodities, leveraged loans, junk bonds and a whole host of areas that are extremely vulnerable."

Shilling says systemic risk is a legitimate concern because of what he calls "counter-party risk" to investors on the other end of a derivative trade from the loans going bad.

"If you get widespread counter-party failures, then the whole system is in trouble," he says.

The Street

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2. ACA Capital deal buys some more time

Troubled bond insurer ACA Capital Holdings Inc. announced late Sunday night that has reached a new forbearance deal, buying it another month to come up with a more permanent solution to its problems.

New York-based ACA has been teetering since credit-rating agency Standard & Poor's said in early November that it might cut the company's rating.

On Sunday, ACA said that its structured credit counterparties have waived all right to ask it to post collateral until Feb. 19. That effectively extends the previous standstill agreement that was reached about a month ago.

“The company is pleased to have reached an additional short-term agreement with its counterparties and continues to work closely with them to develop a permanent solution to stabilize its capital position,” it stated.

Roughly 30 banks from around the world have been working with ACA on the forbearance agreements, including Canadian Imperial Bank of Commerce, which had hedged $3.5-billion worth of complicated securities (that were tied to the U.S. subprime mortgage market) with ACA. However, earlier this month CIBC took a $2-billion (U.S.) write-down (for the two months ended Dec. 31) entirely related to its ACA exposure, leaving it owed roughly $70-million (U.S.) from the company.

Report Business.com

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3. Next on the Worry List: Shaky Insurers of Bonds

Even as stocks ended five days of losses with a surprising recovery on Wednesday, officials began moving to defuse another potential time bomb in the markets: the weakened condition of two large insurance companies that have guaranteed buyers against losses on more than $1 trillion of bonds.

Regulators fear a possible chain of events in which the troubled bond insurers, MBIA and Ambac, might be unable to keep their promise to pay investors if borrowers default on their debt.

That could leave the buyers of the bonds — including many banks and pension funds — on the hook for untold billions of dollars in losses, shaking confidence in the financial system.

To avoid a possible crisis, insurance regulators met with representatives of about a dozen banks on Wednesday to discuss ways to shore up the insurers by injecting fresh capital, much as Wall Street firms have turned to outside investors recently after suffering steep losses related to subprime mortgages.

While it is unclear what steps, if any, the banks and regulators may ultimately take, the talks focused on raising as much as $15 billion for the companies, according to several people briefed on the discussion who asked not to be identified because of the sensitive nature of the discussions.

NY Times

Wallstreet's financial frankensteins are still lose in the village. It's interesting to hear talk about 'regulators' knowing all of this is about unregulated finances.

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4. Goldman Sachs Values Bond Insurers

Goldman Sachs Values Bond Insurers (ABK, MBI, SCA)

Goldman Sachs issued an interesting note on the various bond insurers, although some of this data may have been put out yesterday. The firm is listing three scenario valuation assumptions for:

Ambac Financial (NYSE: ABK)
MBIA Inc. (NYSE: MBI)
Security Capital Assurance (NYSE: SCA)

It is also listing these valuations under three different scenarios:

1. "run-off scenario" where the insurers won't raise enough capital to satisfy ratings agencies and where they may struggle to write new business.
2. "ongoing concern scenario" assumes a capital raise in-line with losses with no added book value and a derivative mark-down.
3. "bailout scenario" as best case where the firms receive capital injections sufficient to operate as is.

GOLDMAN SACHS VALUATIONS

STOCK......Run-Off.......Ongoing Concern.........Bailout
ABK...........$15.............$10..................$35
MBI...........$6..............$14..................$48
SCA...........$0..............$1.50................$13

Yesterday's closing prices were ABK $13.70.... MBI $16.61...... SCA $3.79.

WallSt 24/7

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5. Bond insurers seen needing up to $200 bln

NEW YORK, Jan 25 (Reuters) - A government-brokered rescue plan for U.S. bond insurers of about $15 billion came under fire on Friday, with analysts saying the ailing insurers may need as much as $200 billion to remain viable.

A cash infusion would allow the bond insurers to maintain their top credit rating, which is critical to their business of guaranteeing some $2.5 trillion of municipal bonds and asset-backed securities.

Analysts warned some investors would face huge write-downs on the valuation of securities guaranteed by the insurers if they lost their top credit rating, dealing another blow to a bruised U.S. economy. Those concerns contributed to a recent sell-off in stocks.

New York State Insurance Superintendent Eric Dinallo pressed major Wall Street banks this week to contribute billions of dollars to support the bond insurers, also known as "monoline insurers".

Some observers on Wall Street and elsewhere believe the New York state-orchestrated plan, which is only in the initial stages, may not go far enough.

Forbes

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6. NY State Helped Start Bond Insurance Crisis

How NY State Helped Start Bond Insurance Crisis (ABK)(MBI)(C)

Ambac (ABK) and MBIA (MBI) figured they could improve their earnings by putting money into swaps and derivative instruments. For years they were not allowed to. They had to watch big banks and investment houses turn in better numbers because they had access to the higher risk/reward paper issued by the mad scientists at places like Goldman.

Now, the New York state Insurance Superintendent Eric Dinallo is trying to get big banks to put up $15 billion in lending to bail out the bond insurance operators. It does make some sense. If the institutions lose their ratings the bonds which they cover could drop in value. Banks hold many of those bonds, so that could trigger more write-offs at places like Citigroup (C).

The irony to all of this is that in 1998, NY State gave the green light to bond insurers taking on more risk. According to The Wall Street Journal Financial Security Assurance, a bond insurer, asked that New York insurance regulators allow them to sell credit-default swaps on asset-backed and mortgage securities.

The answer should have been "no". Bond insurance companies have a quasi-public function. They allow states and cities to borrow money more cheaply by insuring the yields on their debt. Infrastructure gets built more cheaply. The ease of bringing in assets allows local taxes to be lower. It has worked that way for decades.

The bond insurers got their wish. They took on more risk. The taxpayer will get the bill.
24/7 Wall St

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7. A Warning on Insurers Frays Nerves

While the Federal Reserve tried to soothe Wall Street’s nerves on Wednesday, a hedge fund manager frayed them by warning that two pillars of the financial markets might crumble.

Even as the Fed delivered another big cut in interest rates, William A. Ackman, a prominent money manager, fanned growing fears that the bond insurance industry might suffer crippling losses.

Mr. Ackman, who runs a New York hedge fund called Pershing Square and has bet against the insurers’ shares, issued a report late in the afternoon predicting that two of the companies, MBIA and the Ambac Financial Group, might lose $24 billion on complex mortgage investments they have guaranteed. Such a hole might threaten their survival and touch off a chain reaction of losses at some of Wall Street’s biggest banks, as well as raise borrowing costs for states and municipalities.

His report, along with the downgrading of a smaller bond guarantor, helped quash a rally in stocks caused by the Fed’s rate cut. The Standard & Poor’s 500-stock index closed down 0.5 percent after being up by as much as 1.7 percent an hour before the close. Shares of financial services stocks fell about 1.1 percent.

“Here comes Ackman at the 11th hour upsetting the apple cart,” said Douglas M. Peta, chief market strategist at J.& W. Seligman & Company. “I don’t think anybody has really thought it all through, but we all understand the implications of real trouble in the bond insurers could be far reaching.”

NY Times