Category: bond insurers

Subprime contained in pandora’s box

No less than 5 days after last weeks emergency Fed meeting, Bennie and his merry men were at it again yesterday when they lowered rates by another 1/2%. This total 1.25% cut matched the last desperation move orchestrated under Alan Greenspan back in 1989. Maybe one of the issues keeping Bernanke up all night revolves around this annoying “little” problem:

Losses from securities linked to subprime mortgages may exceed $265 billion as regional U.S. banks, credit unions and overseas financial institutions write down the value of their holdings, according to Standard & Poor’s.

S&P cut or put on review yesterday the ratings on $534 billion of bonds and collateralized debt obligations tied to home loans made to people with poor credit, the most by the New York- based firm in response to rising mortgage delinquencies. Moody’s Investors Service today said losses from mortgages that were packaged into bonds in 2006 could rise to 18 percent.

Of course S&P and their ilk were all embracing the $50 billion containment theme several months ago yet it now looks like Pandora’s box has finally opened. Adding insult to injury for commercial banks is the latest from one of the wise men, Bill Ackman of Pershing Square, who maps out the monoline insurance issues:

“Up until this point in time, the market and the regulators have had to rely on the bond insurers and the rating agencies to calculate their own losses in what we deem a self-graded exam,” Ackman said in a statement preceding release of the letter. “Now the market will have the opportunity to do its own analysis.”

My comments: Further downgrades of the monolines will require approximately $200 billion in fresh capital to make the entire industry AAA rated according to Sean Egan of Egan, Jones & Co. Add in ongoing mark to market losses within the commercial/investment banking business and another $200 billion in new capital is required to recapitalize the system. Of course the interventionists have a “plan” yet we realize all government “plans” lead to additional distortions prolonging the inevitable cleansing process. Can’t we have a nice garden variety recession in order to level the playing field for real wealth creators?

Another $148 billion needed by banking system?

Since August the international financial community has slowly moved from denial to reality. Specifically, over the past 5 months banks have written down over $130 billion in subprime related debt while going hat in hand to a plethora of sovereign funds.

Middle Eastern and Asian investors have contributed about $59 billion to U.S. and European banks after more than $130 billion of write downs from mortgage-related assets. New York- based Citigroup Inc. said last week it is selling $14.5 billion of preferred stock to investors including Singapore, adding to a $7.5 billion investment in November from the Abu Dhabi Investment Authority, the world’s richest sovereign fund. “We still believe the U.S. promises good returns,” Sultan bin Sulayem said today. “Banks present opportunity. Real estate in Manhattan presents opportunity.”

So are we nearly done in the corrective process or are there additional skeletons in the closet? As we discussed in the Wall Street Journal (October of last year) this process is just beginning as the daisy chain of cloud financing touches many aspects of the credit realm. Wait no longer as the recent downgrades in bond insurers create one more set of problems for the money shufflers.

Banks that raised $72 billion to shore up capital depleted by subprime-related losses may require another $143 billion should credit rating firms downgrade bond insurers, according to analysts at Barclays Capital.

Banks will need at least $22 billion if bonds covered by insurers led by MBIA Inc. and Ambac Assurance Corp. are cut one level from AAA, and six times more for downgrades by four steps to A, Paul Fenner-Leitao wrote in a report published today. Barclays’ estimates are based on banks holding as much as 75 percent of the $820 billion of structured securities guaranteed by bond insurers.

“Barclays Capital has come up with a very big and very scary number,” said Donald Light, an insurance analyst at Boston-based consulting firm Celent. “It indicates that the cost of a bailout of the bond insurers is a lot less than the cost of shoring up these banks’ mark-to-market losses.”

Banks may sell stock or subordinated debt to raise additional capital to cover bond insurer downgrades, the Barclays report said.

My Comments: The scramble is on as mark to market losses create yet one more dilutive round of financing for the money center banks. Signs of a bottom? Hardly!

Staring into the abyss

The beginning of 2008 failed to skip a beat as the monoline bond insurers were dealt a hand of financial reality this week. First, MBIA was forced to raise additional capital or risk losing their AAA rating so with hat in hand went to their friends on Wall Street.

MBIA Inc., the largest bond insurer, paid a yield of 14 percent on the sale of $1 billion of AA rated notes, a rate usually charged to the lowest-ranked borrowers. MBIA’s yield is equivalent to 956 basis points higher than U.S. Treasuries of a similar maturity. The extra yield, or spread, on investment-grade bonds is 217 basis points, according to Merrill Lynch index data. The premium to own high-yield, or junk-rated, debt is 663 basis points.

Not to be outdone, the second largest player within the bond insurance game Ambac announced a $32.83 loss per share yesterday!

Ambac Financial Group Inc.’s AAA credit ratings may be cut by Moody’s Investors Service after the bond insurer reported $3.5 billion of writedowns on securities it guarantees and replaced its chief executive officer. Ambac’s losses were more than the company had previously indicated and may portend further declines in the subprime- mortgage securities that Ambac insures, Moody’s said today in a statement.

As the monoline insurers edge closer to the abyss we now receive word that Merrill Lynch has uncovered several billion in losses pertaining to counterparty exposure.

Merrill also reduced the value of bond insurance contracts by $3.1 billion, saying provider ACA Capital Holdings Inc.’s credit rating had been slashed below investment grade, making it a less- reliable counterparty.

The evolution of our cloud financing system leads us to this new fork in the road. Since all of this incremental credit was hedged with credit default swaps how does one know whether or not the insurer can satisfy claims.

A case in point was the collapse of Dublin-based Structured Credit Company (SCC) in December 2007, which is seeing its 12 trading partners lose about 95 percent of what they are owed, according to the Financial Times. SCC was just a couple of years old and was one of a new brand of Credit Derivative Product Companies. It had no credit rating and $200 million of capital on top of which it wrote $5 billion of credit default swaps (25-to-1 leverage, significantly less than many Structured Investment Vehicles). Low and behold, when the credit markets collapsed last summer and SCC was required to post additional collateral on its trades, there was – to quote Gertrude Stein – “no there there.””Court documents show that collateral demands rose from $55 million to $438 million, but SCC ran out of funds after managing to post $175 million, and the game was up.

My Comments: The next shoe to drop on Wall Street will be credit default swaps as a $45 trillion marketplace meets historical bond default rates (investment grade and junk) of 1.25%. Thus, $500 billion of these default contracts will be triggered resulting in losses of $250 billion or more to the “protection selling” party once recoveries are inserted into the equation.

Bond insurers crisis in confidence

The rating agencies are now reviewing credit ratings of bond insurers MBIA and Ambac. Recent downgrades of structured finance seem to be the culprit.

They now guarantee almost $100 billion of CDOs backed by subprime-mortgage securities as of June 30, according to an Aug. 2 report by Fitch.

Banks and investors in CDOs may be forced to write down the debt by more than $30 billion if the debt became uninsured, based on the values that New York-based Citigroup and Merrill Lynch assigned to their holdings in the past month. Merrill wrote down 29 percent of its CDOs and other securities linked to subprime mortgages and Citigroup cut 21 percent.

Insurers are required by accounting rules to reflect the current market value of the guarantees on the bonds they insure through derivatives contracts.

Without guarantees several trillion in debt securities would decline in value while preventing other borrowers from accessing the bond market.

“We shudder to think of the ramifications,” said Greg Peters, head of credit strategy at New York-based Morgan Stanley, the second-biggest U.S. securities firm by market value. “You have politicians, taxpayers, municipalities, states. It just opens up a Pandora’s box. That is a huge destabilizing force.”

My comments: Credit default swaps on MBIA and Ambac are up 10 fold the past 90 days resulting in significant price declines of their insured portfolio. With reserves of only several basis points we believe the emperor has no clothes.

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