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Friday, February 15, 2008

The Monolines: Such A Slow Death

Yesterday was indeed the turning point. FGIC, the fourth-largest bond insurer, was downgraded six levels late yesterday in an already weak market.

FGIC Loses Aaa Insurance Credit Ratings at Moody's (Update2): “FGIC Corp. lost its Aaa bond insurance rating at Moody's Investors Service, which said the company is in worse financial shape than larger competitors MBIA Inc. and Ambac Financial Group Inc.

The insurance units of New York-based FGIC were cut six levels to A3 and may be reduced again, Moody's said today in a statement. MBIA and Ambac shares rose after Moody's said they “are better positioned from a capitalization and business franchise perspective” than FGIC.

FGIC, the fourth-largest bond insurer, is about $4 billion short of the amount of capital needed to justify a Aaa ranking, Moody's estimates. FGIC had been top-rated since at least 1991 until it was downgraded by Fitch Ratings last month after failing to raise enough capital to compensate for losses on subprime mortgage guarantees. Moody's said its assessments of Armonk, New York-based MBIA and Ambac of New York will probably be complete in the next few weeks.”

FGIC, MBIA and Ambac are reeling from their expansion beyond guaranteeing municipal debt to collateralized debt obligations, which repackage assets such as mortgage bonds and buyout loans into new securities with varying risk. As the value of some CDOs plummets, ratings companies are pressing insurers to add more capital.

MBIA and Ambac tumbled more than 80 percent in the past year as they posted record losses of more than $5 billion and concern grew the companies may not get enough capital.”

In case you’re thinking… “It can’t be THAT bad. Why does all this even matter? Why is the market throwing such a temper tantrum over this?”

“A downgrade of the top rated bond insurers would strip $2.4 trillion of municipal and mortgage-backed debt of their AAA guarantee, throwing doubt on the rankings of thousands of schools, hospitals and local governments around the country.”

That’s why… and we all know how the ‘muni’ market is doing…

UBS Won't Support Failing Auction-Rate Securities (Update3): “UBS AG won't buy auction-rate securities that fail to attract enough bidders, joining a growing number of dealers stepping back from the $300 billion market, said a person with direct knowledge of the situation.

The second-biggest underwriter of the securities, whose rates are reset periodically at auctions, notified its 8,200 U.S. brokers of the decision yesterday, said the person, who declined to be identified because the announcement wasn't publicly disclosed. Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Citigroup Inc. allowed auctions to fail as mounting losses from the collapse of subprime mortgages causes capital markets to seize up.

Bank of America Corp. estimated in a report that 80 percent of all auctions of bonds sold by cities, hospitals and student loan agencies were unsuccessful yesterday. That may mean as much as $20 billion of bonds failed to find buyers, based on the $15 billion to $25 billion of auction-rate bonds scheduled for bidding daily, according to Alex Roever, a JPMorgan Chase & Co. fixed income analyst.”

Uh oh. This is what happens when balance sheets are MAXED out. In situations like this rate cuts WON'T help. The mythical Fed is powerless. The banks simply don’t have the available capital. End of story.

“Auctions are failing as confidence in the creditworthiness of insurers backing the securities wanes, and as loss-plagued banks seek to avoid tying up their capital. More than 129 auctions failed yesterday, Kritzmire said.”

If the banks bid in these auctions and nobody else does, then they are forced to take the paper on themselves. Since they can’t afford to take the paper onto their strained balance sheets, they don’t bid… and the ‘muni’ market implodes.

““If you talk to the dealers, their balance sheets are getting flooded with these auction-rate certificates right now,” said Doug Dachille, who oversees $7 billion in fixed- income securities as chief executive officer of First Principles Capital Management LLC in New York. “Right now, the way they're dealing with the issue is they won't bid. That's why we're seeing failed auctions.””

The only real solution is for the banks to go get re-capitalized. However, the trick is to get new capital faster than the old is being destroyed. The capital injections so far, such as Citigroup, have been done to replace capital that was written off. This means that the burden on balance sheets isn’t being reduced.

UBS Falls to Four-Year Low After Posting Record Loss (Update2): “UBS AG fell to a four-year low in Swiss trading after the U.S. subprime mortgage crash led to a record loss and Chief Executive Officer Marcel Rohner declined to predict whether the bank will return to profit this quarter.

Europe's largest bank by assets fell as much as 8.4 percent after reporting a fourth-quarter loss of 12.5 billion Swiss francs ($11.3 billion). Zurich-based UBS took $13.7 billion in writedowns on securities infected by subprime mortgages.”

The $13.7 billion write down is MASSIVE for UBS. That means that UBS now has a balance sheet $13.7 billion smaller. Raising $13.7 billion would not be an easy feat… and it would only bring UBS back to square one. You see now how these ‘muni’ auctions aren’t finding a bid?

Crippled balance sheets can only result in a sharp economic contraction

Banks at Risk From $203 Billion Writedowns, Says UBS (Update1): “The world's banks “remain at risk” of up to $203 billion in additional writedowns, largely because the bond insurance crisis could worsen, UBS AG said.

Writedowns for collateralized debt obligations and subprime related losses already total $150 billion, Finch estimated. That could rise by a further $120 billion for CDOs, $50 billion for structured investment vehicles, $18 billion for commercial mortgage-backed securities and $15 billion for leveraged buyouts, UBS said. “Risks are rising and spreading and liquidity conditions are still far from normal,” the note said.

U.S. monoline insurers MBIA Inc. and Ambac Financial Group Inc. are struggling to maintain the AAA ratings on their insurance units because of losses on residential mortgages, exposing banks to possible writedowns on CDOs guaranteed by the insurers. Monoline insurers guarantee the repayment of bond principal and interest in the event of defaults.

Ambac was the first monoline insurer to ever be downgraded when Fitch Ratings cut it to AA from AAA in January, citing “significant uncertainty” over the insurer's business model.”

That does NOT help with the crippled balance sheet problem. Not at all.

Bank Risk Soars on Concern Bond Insurer Breakup May Fuel Losses: “The cost of protecting banks from default soared on concern a proposal to break up bond insurers MBIA Inc. and Ambac Financial Group Inc. may trigger further credit market losses.

Credit-default swaps on the Markit iTraxx Financial index of 125 banks and financial institutions jumped 6 basis points to 100 at 11:45 a.m. in London, according to JPMorgan Chase & Co. The Markit iTraxx Japan index rose 4 basis points to 86, Morgan Stanley prices show.

New York Insurance Department Superintendent Eric Dinallo said regulators are trying to help the two biggest bond insurers raise $15 billion to avert rating downgrades that may endanger the $1.2 trillion of debt they guarantee worldwide. One option is to split the insurers' municipal bond business from their money-losing subprime-mortgage units, Dinallo said in a Bloomberg Television interview yesterday.”

Know this: The US economy is in a recession... and will stay there for quite some time.