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Bond insurers affected by credit crunch

(NEW YORK) INVESTORS already burned by turmoil from the credit crunch are now worried about unwanted surprises in the industry that insures bonds. In the face of mounting losses in US mortgages, rating agencies are reviewing eight leading bond insurers, which could lead to downgrades. Such a move could ripple across the financial sector, because if a bond insurer is downgraded, most of the securities it has blessed as virtually risk-free are likely to follow. That could spark a new round of sell-offs and writedowns.

‘It would have a domino effect on all of the entities that hold these vehicles,’ said Ed Rombach, a senior analyst at Thomson Financial. ‘They would have to have more write-offs. It’s a vicious cycle.’

Moody’s Investors Service and Fitch Ratings are examining the capital levels and structured debt these firms have insured because they are worried that the deterioration in the mortgage market may expose them to greater losses. Moody’s is expected to finish its review next week. Fitch said that it would complete its review within three weeks. If any company is put on what’s known as negative watch, it would be given a month to increase its capital and have its rating affirmed.

Bond insurers play a critical role in the capital markets because they issue insurance that boosts the credit ratings of more than US$2 trillion in debt securities held in portfolios around the world, including municipal bonds, mortgage-backed securities and complicated debt instruments. The stock prices of leading insurers have been plummeting as investors worry that they may not have enough capital to cover projected losses from securities tied to delinquent mortgage loans. This has put pressure on guarantors to shore up their capital reserves to protect their coveted triple-A ratings. Last Thursday, the parent company of one bond insurer, CIFG Holding, gave it a US$1.5 billion capital infusion. Soon after, Fitch affirmed CIFG’s triple-A rating.

‘The triple-A rating is really the product that they’re selling,’ Thomas Abruzzo, an analyst with Fitch, said in reference to bond insurers in general. ‘They’re selling high financial strength. It’s the highest rating out there and, really, without that rating it’s going to be significantly more difficult to potentially sell your services.’

Jittery times

Just how much of a downgrade would devalue securities these companies insure is unclear, analysts said.

For example, if a company was downgraded to a double-A rating from triple-A, the impact might be minimal, since the spreads, or perceived risk, of owning similar securities with those two ratings may not be that wide.

However, these are jittery times. ‘The people watching this are not going to say, ‘I’m so happy they’re going to be downgraded only to double-A’,’ said Sylvain Raynes, a founding principle of R&R Consulting, a structured-finance consultancy. ‘They’re going to say, ‘This is the beginning of the end.’ And they’re going to want to go before everyone else goes. This is a stampede.’

Any downgrade of a financial guarantor would likely be more than just one notch, said Stanislas Rouyer, senior vice-president of Moody’s financial guarantors team. A downgrade, he said, would need to incorporate not only the reason for the downgrade but also the consequences of the downgrade on the business.

For years, the insurers mostly guaranteed bonds issued by municipalities, public schools and water authorities. Defaults were few, and bond insurers prospered. Triple-A ratings were a given. In recent years, however, many bond insurers have ventured into the business of insuring complicated mortgage securities such as collateralised debt obligations. And with credit markets deteriorating, they have had to write down the value of their insurance contracts on complicated debt and have posted some of their poorest quarterly results in years.

Some veterans on Wall Street are now questioning the viability of their business model. ‘As the credit market continues to weaken, our confidence that the guarantors will survive the credit meltdown is waning,’ Ken Zerbe, an analyst at Morgan Stanley, wrote in a research note this month. ‘At the current stock price, we believe the market is pricing in the loss of their triple-A ratings. Previously, we would have dismissed this as nearly impossible – now we are not so sure.’

The two largest bond insurers, Ambac Financial Group and MBIA, were recently described by Fitch and Moody’s as having moderate to little risk of falling below adequate capital levels. Nonetheless, their shares have fallen by at least half since the beginning of October.

Ambac spokesman Peter Poillon said last Friday that based on where the stock is trading, investors appeared to be doubting the company’s ability to hold on to its triple-A rating. He disagreed with that assessment, saying that the company has sufficient capital to meet the rating agencies’ requirements. ‘We value our triple-A. We know it’s our franchise and we will do anything to maintain it,’ he said.


Source: The Washington Post (Business Times 28 Nov 07)

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