Bond Insurers Have Problems As Well

In all the chatter about the banking system the insurance industry behind many of the bonds also has problems. At this point this industry may not be well understood enough to judge losses, but things certainly are not promising. Text in bold is my emphasis. From Bloomberg:

Bond insurers including MBIA Inc., Ambac Financial Group Inc. and ACA Capital Holdings Inc. face ``massive losses'' over the next few quarters that could test their ability to raise new capital, Egan-Jones Ratings Co. said.

MBIA may lose $20.2 billion on guarantees and securities holdings, Sean Egan, managing director of Egan-Jones, said on a conference call today. ACA Capital may take losses of at least $10 billion; New York-based Ambac may reach $4.3 billion; mortgage insurers MGIC Investment Corp. and Radian Group Inc. may see losses of $7.25 billion and $7.2 billion, respectively, Egan said.

``There is little doubt that the credit and bond insurers face massive losses over the next few quarters and many will be capital challenged,'' Egan said.

Bond insurers have guaranteed billions of dollars of AAA rated collateralized debt obligations backed by low investment- grade rated portions of mortgage bonds. Some of the debt, largely home loans issued in 2006 and early 2007, has been defaulting at record paces. The losses are threatening the AAA ratings of some of the companies' assurance units.

``The refrain that there is little risk because a security has a high rating is no longer valid,'' Egan said.

The Egan Jones loss estimates include existing guarantees, mainly on securities that rely on mortgages for repayment, and on securities holdings, he said. Haverford, Pennsylvania-based Egan Jones is paid by investors to rate debt, rather than by issuers.

Fitch Ratings said yesterday it will spend the next six weeks reviewing the capital of Ambac, MBIA, Financial Guaranty Insurance Co. and CIFG Guaranty to ensure they have enough capital to warrant an AAA rating. Any guarantor that fails the new test may be downgraded within a month unless the company is able to raise more capital, New York-based Fitch said in a statement.

It will be difficult for the insurers to raise capital given the size of losses compared with the companies' public shares, Egan estimates. In the case of ACA, Egan said the expected loss was 100 times the $122 million value of its outstanding shares.

Moody's Investors Service and Standard & Poor's will downgrade the ratings only after problems have become more obvious, Egan said. He dismissed the argument made by insurers that mark-to-market losses won't turn into realized losses.

``You can't say that the whole market is stupid,'' said Egan. ``In my opinion you can assume a slight discount for market dislocations, but it has gone far beyond that.''

Morgan Stanley analyst Ken Zerbe in a Nov. 2 report downgraded the financial guarantee industry to ``in-line'' from ``attractive,'' and questioned whether bond insurers will be able to survive mounting losses on CDOs and other mortgage-related securities that the companies guarantee. CDOs repackage bonds, mortgages and other assets into new securities, and then use the income from the underlying debt to pay investors.

Egan said he expected a few companies could fail and that would cause the federal government to step in to prevent or delay more failures.

The bond insurers have guaranteed more than $1 trillion of bonds issued by U.S. cities and states as well as bonds and securities backed by mortgages, credit cards and other assets, and the guarantee allows borrowers to use the insurers' AAA rating.

Ambac on Oct. 24 reported its first net loss after reducing the value of subprime mortgage-linked securities it guaranteed by $743 million. A day later, MBIA reported its first-ever quarterly loss because of $342.1 million in pretax writedowns, mostly on a drop in the price of mortgage-related securities. ACA, which is scheduled to report third-quarter results tomorrow, had a second- quarter loss because of markdowns.

Radian, the third-biggest U.S. mortgage insurer, reported a third-quarter loss of $703.9 million after being roiled by claims from failed home loans. Milwaukee-based MGIC, the largest U.S. mortgage insurer, posted its first quarterly loss in 16 years and said it won't be profitable in 2008 as foreclosures increase.