Credit Crisis Tentacles: Bond Insurers
A: Such an important topic to discuss and one that we talked about months ago. Proof the credit crisis has tentacles, ratings agency Moody's threatened to downgrade the credit rating of Ambac, a bond insurer. Stretching this news out, Merrill plans to write off $2.6 Billion of default protection from Ambac & others, because that very protection of the toxic CDO's held, are now worthless. This is one of the events we discussed months ago that posed a possibility of haunting us as the credit cycle continues to play out.
First the news. According to Yahoo Finance article "Moody's Sinks Bond Insurance Stocks":
Bond insurance stocks plunged Thursday after a ratings company said Ambac Financial Group Inc.'s plan to raise cash may not be enough to save its crucial credit rating. Moody's Investors Service said Wednesday night it is considering cutting Ambac's "AAA" financial-strength rating, which would squelch the insurer's prospects for winning new business.Bloomberg has the release on Merrill's write down of $2.6B as they realize the protection they thought they had for their toxic securities is worthless:
"A rating agency downgrade would be the death knell for Ambac," Friedman Billings Ramsey analyst Steve Stelmach wrote in a client note. "Merely the threat of a downgrade complicates the company's capital-raising plans even further."
Ambac and MBIA are under pressure to prove their capital cushions are sufficient to cover claims.
Merrill Lynch & Co., the biggest underwriter of collateralized debt obligations, said it will write off $2.6 billion in default protection from bond insurers including ACA Capital Holdings Inc. because it's worthless. Merrill Lynch's writedowns demonstrate how a downgrade of bond insurer credit ratings can spread throughout financial markets. Losing the AAA stamp would cripple the bond insurers and throw doubt on the ratings of $2.4 trillion of securities.Back in late October, the bond insurers started getting whacked, raising this concern. Then in November, I discussed it in more detail when ACA Capital's stock was halted for news pending.
The bond insurers guaranteed almost $100 billion of CDOs backed by subprime-mortgage securities as of June 30, according to an Aug. 2 report by Fitch Ratings. Most of those guarantees are in the form of derivative contracts. Unlike insurance, those contracts are required to be valued at market rates.
First Bond Insurer Close To Insolvent
If ACA loses its credit rating, they will most likely become insolvent. This is big news folks, because there are many other bond insurers (PMI, ABK, MTG, RDN, to name a few) in deep trouble and if these insurers go, then the ratings agencies will get serious heat, and those trying to receive claims will be left with nothing to get; and we know there are tons of brokerages, banks, and other institutions holding billions of dollars of untradable assets whose losses are yet to be revealed. This will have a crippling effect, the severity of which is the only unknown. You will also start to see heat on the ratings' agencies: MOODY's & FITCH. As the heat is put on, more companies will be put on negative watch and future downgrades of credit ratings are all but guaranteed.Well, the heat was put on and the downgrades are likely to come. The impact of bond insurers going under is massive and will be another shock to the financial system. The reaction will be felt:
a) further writedowns at brokerages/banks of protection they thought they had on toxic securities
b) muni bond meltdown
Jeff discussed the potential impact on the muni bond market as a tentacle to the credit beast on November 19th:
Municipal Money Market Funds. Friday's Wall Street Journal discussed problems with bond insurers and the impact on municipal bonds as well. Municipalities and public institutions like hospitals use bonds to finance themselves and over the years, even those with lower credit ratings have been able to access capital markets easily by using bond insurers to help them attain investment grade status. These same bond insurers also insured CDOs and sub prime CMBSes and as a result of the sub-prime credit debacle stocks of the insurers like Ambac have gotten creamed this year. People are worried about how much of a hit they will take on the insurance they have written. As a result, municipal bonds backed by these same insurers are getting roughed up, raising the cost of new bond issuance by municipalities. You see this credit crunch keeps branching out and side swiping otherwise innocent bystanders.Conclusion: Someone has to save these bond insurers! Their corporate bonds are trading like junk predicting major trouble, and Merrill already decided to write off their insurance protection as a loss. It will get much uglier if more bond insurers go under, so the thing to look out for now is how they may be saved.
Posted by jeff
Fri Jan 18th, 2008 08:42 AM
There's a book called Black Swan that was popular on hedge fund manager's reading lists this summer. Its all about risk and statistical measures of risk and how too many people think financial market risks are bell shaped "normal distributions". In reality, do to the inter-relationships of markets and financial products, many times they act more like "power distributions" as things going wrong reverberate through the system. Statisticians usually use power distributions to describe the likelihood of earthquakes and other rare but often cataclysmic events. We are seeing the Black Swan in action now. Just as municipal governments are being faced with a huge reversal in their tax collection ability (no more real estate deals) and impending deficits, the muni bond market, where they fund themselves could go into paralysis due to the bond insurers going belly up. And this is just one small corner of the inter-related financial market and economic strains from the subprime mess. The correlation of all these negative events at once....which was very hard to anticipate in advance is scary. This patient is getting close to total organ failure and needs some serious medicine.
Posted by Noah
Fri Jan 18th, 2008 09:23 AM
you think we need bone marrow transplant, stem cells injections, or something completely experimental to help this problem?
Posted by Sang
Fri Jan 18th, 2008 09:26 AM
Hey Noah,
So the VIX finally spiked yesterday which is a good indication that selling has climaxed yesterday.
We should expect a bounce as a result, which will provide excellent entry points for PUTs or Short ETFs.
Cheer! and don't let that spunky get to you... =D
Sang
Posted by Noah
Fri Jan 18th, 2008 09:58 AM
hey sang! yes I saw that, I agree that any rally will be more shorting opportunity!
Spunky doesnt bother me, he's a moron. EAH does though. That guy has serious issues and puts so much respect into the experts who expertly guided their companies to billions in losses. Hate when people put words in my mouth and make claims on my behalf that are just untrue.
Posted by Richard
Fri Jan 18th, 2008 02:28 PM
So, how do we save the bond insurers? People are NOT paying the same values for property 2years or even 6months ago. I think up to 2% of these bonds should be forgiven (made to go away) if the markets continue to tank. But, the markets will have to tank A LOT more for that to happen.
Posted by Brenda
Fri Jan 18th, 2008 07:20 PM
Seems like there's an awful lot to save these days. Who's to do it, and with what money? More from the Middle East and Asia? I don't know about the terms behind the recent cash infusions, but there must be some attendant costs. Are we, as an entire nation, moving beyond being merely an enormous borrowing machine to an entire country on the verge of bankruptcy? I'd like to think there is some sort of global economic mutual assured destruction that will keep us afloat, but at what cost?
Posted by sang
Sun Jan 20th, 2008 01:01 PM
Haha, yes that board is full of emotional people. And they are emotional for a reason recently =D
Check out Frank Barbera's articles... first read this:
http://www.financialsense.com/Market/daily/tuesday.htm
Then read his most recent article:
http://www.financialsense.com/editorials/barbera/2008/0118.html
Great shorting opportunities may soon present themselves.
Keep up the good work,
Sang
Posted by Noah
Mon Jan 21st, 2008 10:36 AM
thanks for article Sang..Its getting ugly out there. Im seriously concerned as stocks are getting hit much faster than I thought they would. I thought this would occur over a longer timeline.
I covered my shorts 2 weeks ago; ARGH! Only holding EEV now which shorts the emerging markets. But my other positions will get killed tomorrow.