Thursday, May 15, 2008

Bond Insurer Loses AAA Rating

MBIA: world largest bond insurer reported $2.4bn loss in Q1 2008
  • Fitch Ratings cut MBIA Inc.'s insurance rating to AA from AAA: bond insurer short of $3.8bn capital to warrant the top ranking. Outlook negative.
  • BIS: Monoliners have written roughly $450bn of super-senior protection on CDOs in the form of CDS contracts. About $125bn of these reference ABS CDOs. Counterparties to these trades are large banks, securities firms or off-balance sheet vehicles like ABCP conduits/SIVs.
  • Fitch: As of July 2007: Industry gross insured portfolio = $2.5 trillion; industry shareholder equity = $24.5 bn (=leverage ratio of 100x)
  • The industry guarantees $1.2 trillion municipal bonds and around $800-900bn in structured finance products. CDS portfolio is $463bn (net seller). $287bn (or 61%) of CDS written on corporate bonds; 14% on RMBS.S&P: Banks hedge about $125bn of CDOs with monoliners (senior, super-senior tranches)
  • March 27: FT Alphaville: Fitch downgrades SCA monoline bond guarantor rating from AAA to junk--> needs around $5bn to regain AAA rating. FGIC downgraded again also by S&P--> April 3: FGIC given 30 days by regulator to raise new capital to avoid worst-case scenario.
  • Tett: Some Federal Home Loan Bank (FHLB) member banks want to offer their AAA rating to municipal infrastructure projects. However, FHLB role is already being expanded for mortgage purchases and their capital is stretched already.
  • Fahey/Scott: Exposures to financial guarantors arise from:
    - CDS counterparty exposure associated with CDO, CMBS, RMBS, other ABS and corporate bond hedges;
    - Trading inventories of equity or debt of guarantors;
    - 'Wrapped' securities held in trading or investment portfolios;
    - Muni bonds wrapped in association with Tender Option Bonds (TOB) and Variable Rate Demand Obligations (VRDO) programs [i.e. off-balance sheet entitites with liquidity backstop lines]
    - Loss protection for conduits;
    - Potential support for money funds containing enhanced securities.
  • Davies: Additional risk: unwinding of negative basis trades: difference between higher bond yield and lower cost to insure (with monoliners) that same bond (usually due to oversupply of CDS)--> buying both gives positive and risk-free return usually above Treasuries.
  • Oppenheimer: Banks may write down $70bn if major monolines lose AAA
  • Egan Jones: Bond Insurers Need $200 Billion to Retain AAA

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