Monoline insurers, such as MBIA, Ambac, and FGIC, are in the business of providing financial guarantees. And one of the products they got involved in guaranteeing was mortgage-related structured credits, much to their peril, as we noted back in August.
As subprime losses have mounted, so too have worries about the ability of these guarantors to maintain their AAA ratings. The Wall Street Journal on Friday pointed out that their funding costs were rising, a sign of concern about credit strength:
Financial institutions and bond insurers were targeted by cautious investors. The cost of credit protection on insurer American International Group Inc. and bond insurers such as Ambac Financial Group Inc., rose while their stock prices tumbled as worries about their exposure to the subprime mortgage market mounted.
Today, the Financial Times went so far as to suggest that the monolines might suffer serious mortgage-meltdown damage. This would bode ill for the local governments, since these firms are the main source of credit enhancement for municipal bonds.
From the Financial Times:
Investor worries are mounting that the next big casualties from the credit squeeze might be the specialist companies that act as guarantors for bond issuers.
These companies, which write insurance to boost the credit ratings of various kinds of bonds, have seen their share prices pummelled and the cost of protecting their debt against default soar. Over the past week, sector leaders such as MBIA, Ambac, XL Capital Assurance, Radian and MGIC have all been hit hard.
In recent years, these companies, known as monolines, have moved away from their role of guaranteeing, or wrapping, bonds issued by US municipalities towards writing business related to structured asset-backed finance deals, such as mortgage-backed bonds and collateralised debt obligations.
Following the turmoil in structured credit markets, this business has turned sour, which could affect the cost of borrowing for the local US authorities who rely on their guarantees.
“Our conclusion is that MBIA and the rest of the financial guarantors are facing a prolonged period of stress,” said Rob Haines, an analyst at CreditSights, a research house.
Standard & Poor’s said it was reviewing new data on bond insurers to determine the companies’ ability to weather any further subprime-related storms.
The sector suffered last week, particularly after it produced a string of disappointing third-quarter results, which included hefty writedowns on the value of the insurance contracts written on structured bonds.
MBIA reported earnings on Thursday and saw its shares finish the day 14.9 per cent lower at $46.99. They had recovered to $47.47 on Monday, well off their 12-month high of $76.02.
The cost of protecting $10m of MBIA’s debt against default in the credit default swap market has soared from about $22,000 annually for a five-year contract back in February to more than $231,000 last week, said data provider CMA Datavision.
MBIA and its peers believe the market has overreacted and expect to see the writedowns recovered as the bonds they have insured regain their market values and mature. Michael Grasher, an analyst at Piper Jaffray in New York, concurred that the recent weakness in the financial guarantors was an overreaction: “The market is betting that management has fallen asleep at the wheel. We don’t agree.”