Morgan Stanley also said a bailout of the bond insurance industry is not in the economic interest of banks, though analysts at CreditSights said late on Sunday they now view a bailout as more likely.

Monoline bond insurers are under review by credit ratings agencies and may lose the “AAA” ratings vital to their business.

Rating agencies do not view the bond insurers’ capital as adequate due to expected losses from insuring securities linked to the U.S. subprime mortgage market where defaults have risen.

Some analysts have said they believe U.S. financial institutions exposed to the bond insurers are facing as much as $50 billion to $70 billion in losses, but Greg Peters, Morgan Stanley’s lead credit analyst, said he views exposures as significantly lower.

“That (number) seems too high to us to begin with, and that is a gross number,” he said on Monday on a conference call.

Morgan Stanley evaluated mortgage exposure in collateralized debt obligations (CDOs) insured by the bond insurance arms of Ambac Financial Group Inc, FGIC, Security Capital Assurance, and MBIA Inc, and determined that exposures by U.S. banks is likely in the $20 billion to $25 billion range.

Once the capacity of the bond insurers to pay out claims is taken into account, and assuming that a bankruptcy does not force the insurance arms of the companies out of business, likely losses by banks are in the $5 billion to $7 billion range, Peters said.

Bond insurers typically have holding companies, which issue stock and debt, while the insurance arm generates the income.

While the inability of an insurer to generate new business could weigh on the holding company and potentially drive the stock price down to zero, the insurance arms could continue to operate on their existing business and pay claims, Peters said.

In this scenario, the counterparty exposure of banks to the insurers is negligible, he added.

Peters views a rating downgrade of MBIA or Ambac as likely and argues that supporting ailing insurers is not in the economic interests of banks.

“We just don’t think the incentives exist, banks are clearly capital constrained, the exposure to the monolines is far from uniform, so one dealer might not want to help out their competitor when they have a very limited exposure,” Peters said.

Hedge fund Long Term Capital Management was bailed out by a consortium of banks in 1998 after it faced margin calls on heavily levered exposures to U.S. government bonds and emerging market debt, creating some systemic risk in the view of U.S. regulators.

A consortium of banks is also looking at ways to boost the capital of bond insurers, raising hopes of a similar bailout, though Ambac is the main focus of the plan.

“A LTCM-style kind of bailout is pretty remote,” Peters said on the call.

Unlike LTCM, which was hurt by a temporary liquidity phenomenon, “you’re actually asking banks and dealers to pony up cash to help plug a loss that’s far from temporary.”

Citigroup analysts agreed a bailout is unlikley. “The scale of their losses on CDOs of ABS both explains why a bailout has been so slow in coming, and makes one unlikely in future,” Citi analysts said in a note sent on Monday.

“While political intervention is always hard to judge, we therefore think downgrades probably will take place, albeit of uncertain magnitude,” they added.

CreditSights analyst Rob Haines, however, argued that comments made by U.S. regulators, including Treasury Secretary Henry Paulson, who said last week he was monitoring the situation, make a bailout increasingly likely.

“Based on numerous comments from various regulators, we believe that the economic argument for a bailout is likely to build momentum,” Haines said in a report published late on Sunday.

As new entrants enter the bond insurance business and some existing insurers hold onto their top ratings, the markets may not need insurers such as Ambac, Morgan Stanley’s Peters said.

Financial Security Assurance, Assured Guaranty Corp, whose “AAA” ratings are not under review, and the new market entrant created by Warren Buffett’s Berkshire Hathaway Inc will likely be sufficient to satisfy market needs for bond insurance, Peters added.

“We’re not convinced that you need to have existing monolines still up and running as you have other ways that you could actually wrap that risk.”

Removing TAF makes a significant difference.

$50 billion to be exact.

TAF operations are ongoing. So this discrepancy would just continue to grow.

LIBOR is also starting to misbehave, again. Nothing too serious yet (not like before Christmas) but you get my drift. Stress is creepying back into the system.

The (counter trend) rally in risky assets should just about be over, if I’ve interpreted this correctly.

TheFinancialNinja

Video

FT REPORT – FUND MANAGEMENT: The world of municipals and Mr Buffett

http://search.ft.com/ftArticle?queryText=world+of+municipals&aje=true&id=080204000056&ct=0

The premise of the piece is that there is a strong correlation between Ratings Agency Ratings and Credit ratings as opposed to the actual risk of default

i.e.

To take an example, a study by Standard & Poor’s showed the 10-year cumulative default rate on single-A rated municipals was 0.04 per cent; on corporates it was 1.8 per cent; and on CDOs it was 2.7 per cent. In fact, this low default rate for single-A rated municipals was even better than that of corporate triple-A rated bonds, which recorded a rate of 0.44 per cent.

Additionally, when municipal bonds default the expected recovery rate is 90 per cent compared with 50 per cent on corporate bonds. Moody’s, in a recent study, said if states were evaluated in the same way as corporates, 49 of them would be rated triple-A.

This rather undermines the whole model for Bond insurance

Leads me to the question – was it such great value when they pumped money into it first time round? I can see why the banks are keen to rescue the monoliners. However I would struggle to see why private equities would want to rush in to take on exposures to monoliners (implied in it hence credit defaults, CDOs and the host of related toxic) at this stage.

The MIBA PR exercise last week did nothing except to leave me more disturbed. We will have to see further developments of the allegations of Ackmann goes. The longer the accused does not come out to counter or discredit Ackmann’s allegations, what is the market going to think? That upon a rescue by the banks – thsee monoliners are going to come roaring back and business as usual? Come on … if only pigs can fly.

festerpig