An Investment Banker's Take On Life: Bond Insurers: Too Important To Fail?...Last Part

Out of the hospital?

Bloomberg reported that Asian stock markets rejoiced today, hitting a three-week high, on the back of the good news that MBIA and Ambac were able to keep their S&P AAA-ratings after a suspenseful wait of several weeks, while the credit ratings agency did its review. What does the S&P action mean? Have these top monolines been discharged from the hospital or are they just out of the intensive care unit?

Based on the details surrounding the S&P move, however, it looks more like the latter--out of mortal danger but still very ill. Take a look at these excerpts from Christine Richard's report:

MBIA yesterday suspended its asset-backed securities guarantee business for six months, said it would separate that unit from its municipal guarantees and eliminate the quarterly dividend. New York-based Ambac is working with banks to find $3 billion as the companies try to satisfy Moody's Investors Service and Standard & Poor's that they deserve AAA ratings.

S&P signaled the bond insurers may be successful. The ratings company yesterday said it was no longer reviewing MBIA and affirmed Ambac's AAA rating pending its ability to raise new capital.

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S&P said Armonk, New York-based MBIA remains on negative outlook, meaning that any ratings move may be lower, though not any time soon. Ambac, which ranks second to MBIA among bond insurers, is being given more time to avoid a downgrade, S&P said.

See? MBIA and Ambac narrowly missed S&P's downgrade call because of some contingent actions they committed to do in the near future, like MBIA spinning off its muni bond guarantee operations and Ambac raising additional capital down the road. They are not really out of the woods yet, moreso when we consider that there are two other credit ratings agencies breathing down their necks--Moody's and Fitch Ratings. According to Bloomberg:

Moody's is still reviewing MBIA and Ambac for downgrades. Fitch Ratings cut Ambac's insurance rating to AA last month and is considering cutting MBIA.

Failure is not an option

The monolines' saga is far from over, but this series has to end somehow so I can move on to other issues (and there are many in this subprime mess). I focused on the plight of the bond insurers because of the strategic role that they perform in a modern financial system. I get dizzy whenever I consider these statistics which I collated from various online sources:

--Over $2.4 trillion of debt was guaranteed by the U.S. bond insurers.

--Roughly half of the $2.6-trillion muni bond market was insured by the monolines.

--About $820 billion of structured securities, of which CDOs comprised $127 billion, were guaranteed by bond insurers.

--As of September 2007, MBIA guaranteed $432.7 billion in muni bonds and $240.3 billion in corporate and mortgage-related bonds, of which about $83 billion were CDOs.

--Ambac has exposure of about $67 billion to CDOs.

--Loss of the monolines' AAA-rating could cost investors as much as $200 billion.

--Merrill Lynch has insurance on nearly $20 billion top-rated CDOs on its books.

--Citigroup and Canadian Imperial Bank of Commerce each have some $10 billion CDOs also on their books with similar contracts.

Given those numbers (and they are yet incomplete) I am not surprised that S&P cleared MBIA and Ambac, allowing them to keep their AAA-ratings contingent on specific deliverables. There is simply so much at stake and Herb Greenberg summed it up best when he said: “The rating agencies are like the kid who has his thumb in the dike. They simply can’t take it out because if they do they’ll pull the whole system down with it.” I guess S&P would not want to be that kid.