Bond Insurer Death Watch Continues

Bloomberg reports that Standard & Poor’s has announced that it will review bond insurers’ ratings a mere month after reaffirming the scores of MBIA and Ambac, due to subprime losses exceeding the rating agency’s assumptions. Note this move was anticipated, but the statement suggests the fate of the bond guarantors has elevated priority and the review is to be finished within a week.

Bloomberg has also released an exclusive story, “MBIA’s Capital Need Grows, Credit-Default Swaps Show .” The deteriorating outlook (MBIA’s 14% notes issues last week have traded down 12%) bears out the views of hedge fund Pershing Square, which is short the holding company stock and has been quite vocal in saying what a mess MBIA and Ambac are.

Reader Will T pointed us to a link to a Bloomberg interview with Bill Ackman, Pershing Square’s chief. He updates some of the information contained in his firm’s detailed and persuasive analysis as of end of November. A sample comment: Pershing Square believes, based on MBIA’s latest SEC filing, that the firm will need $10 billion in additional capital to maintain its AAA rating, up from an estimate of $8 billion in November (note that this is the requirement over time, not an immediate need).

Will T also provided a good list of highlights:

* MBIA’s numbers are presented net of reinsurance. About half of the reinsurance comes from Channel Re (rated AAA with $300 million capital)
* MBIA helped set up ChannelRe in 2004 with a 17.4% ownership stake. ChannelRe provides reinsurance services exclusively to MBIA.
* MBIA shifted their riskiest exposures to ChannelRe. ChannelRe expects $200 million in credit impairments from a $3.3 billion mark-to-market charge at MBIA.
* $42.2 billion of MBIA’s reinsurance is from ChannelRe.
* MBIA needs to raise in excess of $10 billion of capital, depending on circumstances.
* If MBIA does not cut the dividend and cannot access cash held at its investment management subsidiary, they run out of cash at the end of this June. If they are able to access the cash, they run out of money by the end of this year.

Back to the Bloomberg story on the S&P announcement:

The ratings company will examine whether insurers including MBIA Inc. and Ambac Financial Group Inc. have enough capital to withstand reductions in the ratings of the mortgage-backed securities they guarantee. The credit test will be completed within a week, said Mimi Barker, a spokeswoman in New York.

S&P is now assuming losses on 2006 subprime mortgages will reach 19 percent, up from 14 percent….

“The rating agencies have lost as much credibility as the bond insurers,” said Richard Larkin, a municipal bond analyst with JB Hanauer & Co. in Parsippany, New Jersey. “Every time you turn around they’re changing their minds about what’s going to happen in the subprime mortgage market.”

After completing a test of the financial guarantors on Dec. 19, S&P put the AAA ratings of MBIA, Ambac, Security Capital Assurance Ltd. and CIFG Financial Guaranty on negative outlook. The firm placed FGIC Corp.’s AAA rating under review for a possible downgrade….

Earlier today Ambac announced plans to sell $1 billion in equity and equity-linked notes and said it was cutting its dividend by 67 percent. Fitch Ratings had given the company until the end of the month to raise $1 billion to avoid a cut of its insurance rating to AA+.

Fitch also affirmed MBIA’s AAA rating, citing its completion of a $1 billion surplus note sale last week. The notes priced at a yield of 14 percent.

From the Bloomberg story on MBIA’s credit default swaps:

The worst may still be ahead for the world’s biggest financial companies, trading in credit-default swaps shows.

Prices for contracts tied to the bonds of MBIA Inc., Bear Stearns Cos. and Washington Mutual Inc., which protect lenders and creditors against the possibility that debt payments won’t be made, are higher for one year than for five, according to data compiled by Bloomberg. Longer-term protection is usually more expensive because the risk of nonpayment is greater.

It still costs more to take out insurance against default for one year even after New York-based Citigroup Inc., the largest U.S. bank, obtained $14.5 billion yesterday to shore up depleted capital. Lenders hold more than $200 billion of bonds and loans used to finance leveraged buyouts that they can’t sell and are falling in value, based on data compiled by JPMorgan Chase & Co.

“It’s very dangerous for some of these big institutions,” said Doug Noland, a credit analyst in Dallas at David W. Tice & Associates. The firm’s $924 million Prudent Bear Fund has returned 23 percent in the past year. “We’re going into an acute liquidity crisis for corporate borrowers.”

Most of the so-called inverted credit curves are concentrated in securities firms, banks and bond insurers that reported more than $100 billion in losses on mortgages to borrowers with poor credit. New York-based Moody’s Investors Service last week predicted corporate defaults for all companies would rise fivefold this year as the economy slows…..

Credit-default swaps on MBIA, which itself sells protection against bond defaults, rose to the equivalent of 18.6 percent for one year after credit rating companies threatened in November to strip the Armonk, New York-based company of its AAA rating. That would have effectively crippled its ability to guarantee debt.

For five-year coverage, sellers are seeking the equivalent of about 9.8 percent a year, according to CMA Datavision.

The 18.6 percent translates to $1.86 million on $10 million of debt and implies a more than 30 percent chance that MBIA will default in the next year, according to a JPMorgan valuation model. For five-year insurance, holders would pay about $980,000 a year.

Six months ago buyers paid 0.23 percent for one-year credit- default swaps and 0.87 percent a year for five-year contracts. For every $10 million of debt, that’s equivalent to $23,000 for one year and $87,000 annually for five years. A higher price indicates a lower perception of credit quality…..

The cost of one-year credit-default swaps may reflect even more concern as investors use them to hedge against the risk that firms on the other side of their trade may not pay obligations. The potential for a bond insurer such as MBIA to collapse has prompted investors holding securities insured by them to use credit-default swaps to hedge against the risk of default.

Print Friendly, PDF & Email


  1. foesskewered

    Read the same bloomberg articles, what was a little confusing was the explanation for the inversion – that investors thought shoulkd these bond insurers survive the next few months, their “creditworthiness” would recover, hence the lower premiums for the 5 year contracts. Is it as simple as that? The way things look, it would be really tough for any rapid recovery of the situation, if that’s the case and these companies don’t survive the next couple of months, won’t the 5 year contracts (cds) be worthless? Dumb questions but that’s me on a good day.

  2. Yves Smith


    That’s how I read it too, It may be poor drafting on the part of the journalist; I’ve seen that upon occasion.

    The assumption may be that if they survive the next few months, it will be by virtue of adequate fundraising. Events won’t bail them out.

Comments are closed.