Bond Insurers Becoming More Troublesome

This could really put a wrench in things - I didn't realize Ambac (ABK) got downgraded below Triple A Friday. It doesn't sound like much but in this business if you don't have triple A credit you have nothing. As I wrote yesterday, Sword of Damocles. Mr Buffet, is going to be printing money in this business.

• A downgrade of bond insurer Ambac Financial Group Inc. is likely to have far-reaching effects, making it more difficult for cities to issue new bonds and forcing further write-downs at financial services companies, analysts said Friday.
• After Ambac scrapped plans to raise $1 billion in capital, Fitch Ratings cut the company's crucial financial strength rating to "AA" from "AAA."
• The downgrade likely means Ambac will not underwrite any more business, said John Flahive, director of fixed income for BNY Mellon Wealth Management. Market prices of existing bonds insured by Ambac and MBIA Inc. were trading lower before the downgrade, and Flahive suggested any downgrade could accelerate the decline.
• Ambac and chief competitor MBIA together insure $700 billion in municipal bonds, and MBIA's "AAA" rating is also under threat. The company issued $1 billion in bonds this week to preserve the rating, though that may not be enough to satisfy the ratings agencies. MBIA said in a statement Friday it intends to keep working toward maintaining its "AAA" rating.
• Since late last year, when the agencies first raised the prospect, analysts have suggested any move to cut Ambac or MBIA below "AAA" could be disastrous. The concern is that downgrades will lead to a reduction in the value of portfolios at dozens of financial institutions, said Donald Light, a senior analyst at Celent LLC. "Bond insurers are the lynchpin holding together valuations of portfolios of all kinds of financial institutions," Light said.
• Prior to Ambac's downgrade, T.J. Marta, a fixed-income analyst at RBC Capital Markets, said a downgrade of the company would lead to downgrades of all the municipal bonds it insured. Subsequently, it will become more difficult for cities, counties and other local entities to issue debt for building projects, Marta said. (again, the whole credit system is a house of cards - one part is dependent on another - when one domino falls, the ripple effect is felt everywhere - that's what makes this whole situation so frightful)
• At the very minimum the troubles of the insurers will drive up borrowing costs of cities and other local entities at a time when many are strained by weaker tax revenue, said John Atkins, a fixed-income analyst at IDEAGlobal.com.
• Buffett launched a new bond insurance business in December that has a "AAA" credit rating and a solid balance sheet. Buffett's new company also has the benefit of having no questionable loans on its books.

Barron's says....

• THE COLLAPSE OF BOND INSURERS is the latest symptom of the credit crisis that has spread from subprime mortgages to throughout the financial system.
• ... the unraveling of bond insurers, which provided a fig leaf of protection to risky investments in collateralized debt obligations. Indeed, part of Merrill Lynch's stunning writedown and loss for the fourth was the complete writeoff of CDOs insured by ACA, a second-tier insurer.
• The more profound fissure opening is the potential for the loss of the triple-A guarantee rating for market leaders MBIA and Ambac, which would virtually put them out of business. Their business model depends on their ability to put the imprimatur of a triple-A rating, effectively performing the modern-day alchemy of turning leaden credits into gold.
• Reflecting that potential downgrade, shares of Ambac plunged 52% Thursday after Moody's served notice its triple-A rating was in jeopardy. MBIA's shares lost 31% but even more stunning was the loss in its new 14% capital notes, just issued to shore up its capital. This $1 billion issue, which just closed Wednesday, plummeted to 77 cents on the dollar, putting its yield all the way to 21.75%.

TheStreet.com Weighs In:

• Recession is no longer the taboo word on Wall Street. It's being tossed around like confetti. The new phrase that can't be uttered is "systemic risk," and with bond insurer Ambac (ABK) losing its triple-A credit rating from Fitch Ratings on Friday, the real risk of a financial disaster will be widely whispered into the next week amid the possibility of more downgrades for the industry.
• T.J. Marta, fixed income strategist with RBC Capital Markets, estimates that roughly $2.5 trillion in outstanding debt is backed by bond insurers like Ambac and MBIA (MBI), and credit downgrades are a mortal threat to their business models.
• If the bond insurers fail, that raises the specter of a massive wave of wealth destruction in a global financial system that is flooded with illiquid and opaque derivative securities of which there is little understanding, except that their value is connected to credit ratings on structured finance securities
• "This is going to be worse than anybody thinks," says Marta. "What I heard from Ambac [on Friday] is that they're throwing back the lifeline and saying, 'We're not going to make it.' On a fixed income trading floor, that means the world truly is upside down."
• "Next week, we'll be waiting for not just the next shoe but many more shoes to drop," he says. "That's the bottom line here. The subprime slime was the first to go because those are loans to the least credit-worthy borrowers -- the most vulnerable. But you had plenty of speculation in commercial real estate, emerging market debt and equities, commodities, leveraged loans, junk bonds and a whole host of areas that are extremely vulnerable." (sounds vaguely familiar)
• Many investors are looking abroad to places like China for healthy investments in light of the troubles at home, but Shilling calls this idea "nonsense." He says the next shoe to drop in the downturn he's predicting could be a major sell-off in China. "China really relies on U.S. consumers to buy their exports and those exports are absolutely critical for their continued growth," says Shilling. "They don't have a big enough middle-class yet to be able to sustain the economy with domestic spending." (sounds vaguely familiar)

Cramer, Kass, and the guys over at Minyanville have been pointing out these bond insurers as a systematic risk for months on end. Apparently the academics at the Fed don't read either website. I guess they will react after the implosion.