Credit Default Prices Up Sharply on MBIA Losses, Planned S&P Ratings Actions

The turn of phrase in financial reporting can sometimes be a hair misleading. Today’s Bloomberg story reporting on marked price increases in the credit default swaps market in the wake on news overnight from MBIA and Standars & Poor’s, starts out by saying, “The risk of companies defaulting soared…..”

No, the risk of companies defaulting did not soar in a mere 16 hours. The perceived risk of companies defaulting did.

From Bloomberg:

The risk of companies defaulting soared after bond insurer MBIA Inc. posted a record loss and Standard & Poor’s cut or put on review ratings on $534 billion of bonds and collateralized debt obligations….

“The market has accounted for only half those losses,” said Mehernosh Engineer, credit strategist at BNP Paribas in London. “The question is, where are the rest of the losses?”

Credit-default swaps on MBIA rose to $1.85 million upfront and $500,000 a year to protect $10 million of debt from default for five years, according to CMA Datavision. The upfront cost was $1.8 million yesterday. Contracts on Ambac Financial Group Inc., the second biggest bond insurer, were unchanged at $1.9 million in advance and $500,000 a year. The contracts trade upfront when investors see a risk of imminent default……

Almost half the subprime bonds rated by S&P in 2006 and early 2007 were cut or placed on review, potentially forcing credit unions and government-sponsored enterprises such as Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks to write down their holdings, the firm said. The securities represent $270.1 billion of subprime mortgage bonds and $263.9 billion of CDOs. About 35 percent of all CDOs comprised of asset-backed securities were put under review, S&P said.

“Does it stop here or will it increase?” said Engineer at BNP Paribas. “If it increases, we’ll start going into a credit crunch again because it will start sucking up capital on to financials’ balance sheets.”

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  1. Anonymous

    I hear what you’re saying, but …

    If insurers’ liabilities and collateral calls are a function of pricing of insured securities, and pricing of insured securities is a function of prevailing S&P ratings, I would have that the actual risk of default by insurers had increased, albeit marginally, but meaningfully.

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