Ambac & MBIA Ratings Maintained

A: Any way you slice it, this is positive news and since the Ambac rumor came out on Friday, this chapter of the bond insurer saga was good for about 400 DOW points so far! What is more positive in my mind, is MBIA's announcement as that came as a bonus since the Ambac rumor was released to us on Friday and everyone I talk to was waiting on that resolution. Getting ratings affirmations for both these guys does two very important things: adds clarity/confidence to tradabale markets + saves a round of write-downs for financials that would have come if the downgrades hit. I caution you to interpret this as a solve all fix, as it is very possible we will revisit bond insurance ratings issues if credit markets and housing markets continue to be pressured causing more defaults; especially to higher quality debt classes.

We must understand WHY bond insurers were at risk of losing their 'AAA' ratings in the first place, and that is defaults on bad loans that would result in claims filed by holders of toxic securities! Right now according to MBIA's site, HELOC's & Closed End Second Lien loans are the underperforming bonds with defaulting first loss tranches. I'll do a post on this later in the week but for now, you can see this chart:



Now, between Warburg's capital injections to MBIA and a consortium of banks combining forces to secure Ambac's ratings, the following forces are handed to the tradable markets:

a) short term clarity; business can continue to be booked
b) a degree of confidence that claims paying abilities are strong
c) removal of threat of a financial shockwave if downgrades came; muni markets residual effects
d) removal of threat of downgrade related write-downs at banks/brokerages

...hence contributing to the 400 point rally since the news started to leak Friday; but it looks like its now priced in at these levels. These are positive and important elements to be given to the markets. However, it does NOT fix:

a) continuing fundamental housing weakness; continuing affordability problem
b) toxic holdings still on books; more write-downs coming
c) rising defaults / foreclosures (Foreclosures Soar 57% in January from year ago levels)
d) continuing credit markets dysfunction
e) spreading of problems to other debt classes
f) slowing economy
g) rising inflation (Wholesale Prices Soar in January)

While I truly want to get excited about this, and I am to a degree as I am no longer as scared as I was when the threat of downgrades for these guys was here, it's foolish to think the rescue of the bond insurers ratings fixes the root problems that caused the downgrade threat to begin with. So, it is very possible that we will have to revisit ratings rescue plans down the road IF credit markets continue to be dried up, housing continues to fall, defaults continue to rise, and the problems spread to other debt classes. But defaults are the key since this data point directly results in a first loss and up the chain of tranches that resulted from loans being packaged up and sold to investors as mortgage backed securities. Look at todays news on foreclosures, according to CNN Money:

Filings saw yet another big jump last month, compared to levels a year ago; 45,327 homes were lost to bank repossessions. Foreclosure filings nationwide soared 57% in January over the same month last year - another indication that the nation's housing woes are deepening.

Subprime, hybrid adjustable rate mortgages, with interest rates that reset to much higher, often unaffordable levels after a two or three year period of low rates, caused many borrowers to default. Even more exotic products, such as interest-only loans, where balances don't shrink, or, worse yet, option ARMs, where balances grow, also contributed to foreclosure problems.

As long as defaults & foreclosures are coming in at these levels, how could we get too excited? The result is that there will be more losses to the bonds securitized by these loans, leading the insurers with more claims to pay out. We need to see this dataset not only stabilize but solidly reverse course before we can talk about being out of the woods. Hey, at least I'm asking the right questions as I painfully try to keep my head above the sand.

Professor Roubini weighs in:

This is a bond insurance firm that – as pointed out by Barry Ritholtz and others – has recently been forced to borrow at rates of 14%, i.e. a much higher rate than average junk bond yields, let alone investment grade ones. Still the pretense has been kept that this firm has an AAA rating, the same as the US government and top notch super-safe US corporations.

How can a firm that can only borrow at spreads closer to those of firms that are borderline bankrupt be given a AAA rating is anyone’s guess. It looks like rating agencies have learnt nothing after having systematically misrated for years RMBS, CDO and other structured finance products. Their reputation and credibility has sunk now even lower than before.

It will be very interesting to see to what degree this news plays on normalizing the credit markets in coming days! Will the market get more liquid? Will bids for toxic bonds come back? If the credit markets start to normalize, that will be a positive leading indicator for helping housing to stabilize. I have my validated doubts and I still think we have more pain to come with rising defaults, pressure in housing markets, slowing economy, and rising inflation. The process still needs to play out and the markets still need to cleanse itself of 5 years of bad bets; its only been about 8 months so far. But its nice to get some closure, for now, to this bond insurer saga.