Reuters Edge

Ambac, MBIA woes could spark more bank losses

NEW YORK (Reuters) - Further credit-rating troubles for bond insurers Ambac Financial Group ABK.N and MBIA MBI.N could spark a new wave of bank losses and batter the value of billions of dollars of insured mortgage investments.

But the world’s two largest bond insurers, which together guarantee payments on over $1.2 trillion of debt, are likely to remain solvent amid further rating actions, since their obligations to cover subprime investors unfold over a long period, analysts say.

Fitch Ratings last Friday became the first agency to cut the crucial “AAA” credit ratings of a top-rated bond insurer, cutting Ambac Assurance Corp by two notches to “AA” in a move that makes it difficult for Ambac to drum up new business and has raised expectations of more downgrades to come.

That could mean more volatility for global financial markets, which swooned on Monday partly on fears about the fate of U.S. bond insurers.

“Further downgrades would likely kick off yet more write-downs” by banks and brokers, said Christian Stracke, an analyst at research firm CreditSights, in a report on Tuesday.

Global banks have already announced nearly $100 billion in potential losses, according to figures from brokerage Friedman Billings Ramsey.

But a severe downgrade of the bond insurers “could have truly systemic implications for the global banking system,” Stracke said.

Ambac on Tuesday reported a quarterly loss of $3.3 billion after recording massive credit derivative write-downs, but its shares surged after the bond insurer said it hopes to find much-needed capital “reasonably soon.”

For months, analysts have worried that bond insurers lack the cash to fulfill their obligations on subprime mortgage bonds packaged into collateralized debt obligations, or CDOs.

As a result, fears have risen that the insurers’ troubles could set in motion a chain reaction that would cripple the mortgage and municipal debt markets, bank lending, and the U.S. economy.

Spokespeople for Ambac and MBIA did not immediately return calls for comment.

“The risk exists that a portion of the ‘hedged’ portfolios at other banks and brokers may be unraveling as the ratings of the monolines decline,” said Brad Hintz and analysts at Bernstein Research in a report on Monday.

Merrill Lynch MER.N last week wrote off almost $2 billion due to exposure to one of the weakest bond insurers, ACA Capital, according to CreditSights.

“The potential impact of a monoline implosion is likely to be far more severe on the toxic subprime CDO market than on municipal bonds,” Hintz said.


Indeed, buyers of mortgage and municipal bonds insured by MBIA and Ambac may take a hit also as these investments suffer their own ratings downgrades and lose value, though much of this may already be baked into current prices.

“That to me is the big thing,” said analyst Bert Ely of Ely & Co. in Alexandria, Virginia.

Still, the effect on the U.S. municipal bond market is likely to be fairly mild, since most of the bonds are highly-rated to begin with, several analysts said.

“You have to have all three rating agencies downgrade first below “double-A”. Until that occurs, there will be initially some strategic selling, but I don’t think there is going to be some wholesale selling,” said Tom Metzold, portfolio manager at Eaton Vance in Boston.

“We have not seen a massive sell-off. Part of it is people are realizing that there could be tremendous value here because there are a number of bonds that are selling at levels at or below their underlying value because of taint,” Metzold said.

However, investors in subprime mortgage bonds, including Wall Street banks, are likely to feel a lot more pain.

Buyers of insured mortgage bonds “would be more likely than the market to sell in a downgrade scenario,” a portfolio manager said. “Regardless of how much they’ve been discounted, the value is going to fall further,” he said.

Still, several analysts said they expect the bond insurers to remain solvent in the near-term despite any downgrades.

“The market’s appetite for having them be the insurer on new deals could drop drastically,” said Mark Adelson, a consultant at Adelson & Jacob Consulting in New York. But “they don’t literally just close their doors.”

But some investors like William Ackman of Pershing Square Capital hold the opposite view, and are expecting a collapse.

Ackman has shorted shares of Ambac and MBIA, meaning the fund profits if the insurers’ shares drop.

“If unable to access additional capital, MBIA Inc could be insolvent as soon as” the second quarter, Ackman said in a presentation last November.

(Additional reporting by Anastasija Johnson in New York)

Reporting by Neil Shah; editing by Clive McKeef