Defaults may spark big loss for insurers: Barclays

NEW YORK (Reuters) - Bond insurers may suffer "an appreciable loss" due to their exposure to subprime mortgage debt, putting at risk their top rating that is critical to their business, Barclays Capital said on Friday.

Monoline bond insurers have guaranteed collateralized debt obligations backed by subprime mortgages, said Barclays analysts. Those securities are deteriorating in value, exposing the insurers to potential losses.

"A scenario in which several (event of default notices) occur within one CDO-squared deal could still potentially represent an appreciable loss for the monoline" insurers, Seth Glasser, Barclays' senior insurance analyst, said on a conference call. A CDO of CDOs is known as a CDO squared.

Bond insurers, such as Ambac Financial Group Inc (ABK.N) and MBIA (MBI.N), currently have excess capital "above and beyond" the minimum to maintain top ratings, Glasser said.

However, rating downgrades and increases to loss reserves may begin to eat away at excess capital, he said.

Rating downgrades of such insurers may spur further rating downgrades of securities that they insure, impacting everything from municipal bonds to asset-backed securities sold by banks.

If a bond insurer faces downgrades on bonds that it has insured, or has to boost reserves, it would need to raise capital to maintain its top rating, Glasser said.

Shares in several of the bond insurers have fallen sharply in recent weeks as investors fear the companies may need to raise capital as losses mount. Shares in MBIA and Ambac were down 1.7 percent and 3.3 percent, respectively, in late Friday trading.

Rating companies Moody's Investors Service and Fitch Ratings are currently revising stress tests for insurers.

Fitch earlier this month said that ratings of bond insurers, including CIFG Guaranty, which is owned by French bank Natixis (CNAT.PA), and Financial Guaranty Insurance Co, whose owners include Blackstone Group (BX.N), may be vulnerable to rating cuts of three notches or more due to their capital adequacy levels.

Barclays' Glasser also said insurers that will need to raise capital most likely will seek reinsurance or private capital injections to maintain their top ratings.

Ambac and MBIA shares rose in Tuesday after the Wall Street Journal reported that the companies are seeking reinsurance from Berkshire Hathaway Inc (BRKa.N).

In another sign bond insurance is losing its appeal, New York City plans to sell $100 million of variable-rate demand obligations next month rather than insured auction-rate bonds.

"We've decided that the current climate is better suited toward the variable-rate demand product that does not need to be insured," Michael Stern, director of debt management at New York City Comptroller's Office, said during a conference late Thursday.

Stern said that the city made the decision on concern that financial guarantors' exposure to the subprime mortgage sector could cost them their AAA ratings.

(Additional reporting by Anastasija Johnson)

(Reporting by Walden Siew; Editing by Tom Hals)