Subprime crisis extends its reach to bond insurers

As the subprime lending crisis has widened, its effect on credit markets has taken some surprising and unanticipated forms.

Last week, Moody's Investor's Service put four of the nation's leading bond insurers on notice that, to retain their vital AAA ratings, they will each have to raise billions of dollars in additional capital.

The four firms -- MBIA, Ambac Financial Group, Security Capital Assurance, and FGIC -- are all in the business of insuring bond issues.

Bond issuers such as the City of Colorado Springs can, by insuring their debt issues with a triple-A rated company, substantially lower the interest rate that they must pay to investors who purchase the debt.

But during recent years, bond insurers, who once confined themselves to stolid, unsexy instruments such as municipal and state- issued debt, have branched out into more profitable areas, including collateralized mortgage obligations, securities backed by bundled mortgages.

Moody's has concluded that the four insurers might have substantial CMO liabilities. The rating agency sees MBIA as most at risk, saying that "additional analysis of its direct RMBS (residential mortgage-backed securities) portfolio leads Moody's to believe the guarantor is at greater risk of exhibiting a capital shortfall than previously communicated; we now consider this somewhat likely."

Moody's was more circumspect about the prospects of the other three, saying only that they are "somewhat likely to exhibit a capital shortfall."

Moody's plans to conclude its analysis Dec. 19, by which time the firms in question might have to raise billions of dollars, or see their ratings cut.

As MBIA's chief executive has stated, the entire business plan of such companies is based on carrying a triple-A rating. Without the rating, they can't offer potential clients the opportunity to upgrade their ratings.

On Tuesday, MBIA announced that Warburg Pincus, a private equity firm, will inject up to $1 billion in fresh capital into the company. Under the terms of the deal, Warburg Pincus will buy 16.1 million shares at $31 each, will receive warrants to buy 8.1 million additional shares and will support a shareholder rights offering to raise an additional $500 million.

But hedge fund manager Bill Ackman, who has waged a one-man campaign against MBIA since 2002, and has made hundreds of millions of dollars shorting the stock, greeted the deal with skepticism, according to the Wall Street Journal.

"I generally think that Warburg Pincus is a very smart private equity firm, but I don't think they understand what they just bought," said Ackman, who heads Pershing Square Capital Management. "It's likely that they'll lose their entire investment."

Colorado Springs, as well as city-owned enterprises such as Memorial Hospital and Colorado Springs Utilities, has often chosen to insure long-term debt issues. And while the problems afflicting the insurers will have no impact on the interest rates of existing bond issues, it could impact future debt, according to Terri Velasquez, the city's finance director.

She said that the city would have to go to the bond market on the strength of its own rating if insurance is either unavailable or prohibitively expensive. But depending on the rating given to a particular issue, that might lead to higher interest payments on city debt, and correspondingly less money to pay for city services.

University of Colorado at Colorado Springs economist Fred Crowley agrees that the impact of more expensive, or unavailable, bond insurance could create difficulties for many issuers.

"For smaller issuers, they have to have insurance, since no one knows anything about them, and their bonds would be unmarketable without insurance," he said. "As for the added (interest) expense, who knows -- 25, 50 basis points, even more? We'll see."

Crowley said the difficulties experienced by bond insurers mirror the current disequilibrium in the economy.

"You've got the production side, building houses, cars, everything we need," he said. "And you've got the credit side, providing financing so we can buy these goods. But (with the current credit crisis) we've got disequilibrium -- there's a lack of confidence in the financial markets, and a consequent lack of liquidity. We're a credit society. Without credit, the economy collapses. We're not going to collapse, but there's certainly a chance of recession."

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