S&P Updates Results of Bond Insurance Stress Test for Revised Assumptions

January 18, 2008

The formerly placid world of the bond insurers has suddenly become as chaotic as the P/C sector after a major hurricane. Standard & Poor’s Ratings Services published a new version of its bond insurance stress tests on January 15. Three days later it published a revised version.

S&P said the “new results show total projected losses for the industry to be 20 percent higher than those in the previous review [released in December]. Individual company increases ranged from a low of 2 percent to a high of 36 percent.” S&P said it has yet to take any rating action “on any company at this time.” However, given the turmoil in the bond insurance market, it seems inevitable that a number of ‘AAA’ ratings are in serious jeopardy.

In an unusual broadcast, the BBC World Service devoted its entire business news coverage this afternoon to an explanation of what bond insurers do, and why their financial troubles could further impact the already shaky capital markets. Basically, if the sectors’ capital is impaired, the interest rates on bonds will rise substantially to take into account the added risk. Business’ borrowing will become more expensive.

S&P’s study concluded initially that those bond insurers with “increased projected losses,” that had stable outlooks, “did not materially impair the adjusted capital cushions.” The rating agency warned, however, that for the other “companies, the fact that their ratings either had a negative outlook or were on CreditWatch reflected uncertainty surrounding the potential for further mortgage market deterioration and the companies’ ability to accurately gauge their ongoing additional capital needs. This latest round of revised assumptions is an example of the deterioration that was contemplated.”

S&P still rates the following companies and their subsidiaries as ‘AAA,’ but it has assigned them a “negative outlook-” Ambac Financial, CIFG Guaranty, Financial Guaranty Insurance, MBIA Insurance and XL Financial Insurance.

S&P did indicate that it does “not view the extent of the deterioration as significant in the context of each company’s capital position and the comprehensiveness and degree of completion of projected capitalization strengthening efforts that are underway.

“The revised assumptions announced by the RMBS surveillance group reflect the growing economic consensus that U.S. home price declines will be larger than previously forecasted and that the U.S. housing market slump may last far longer than previously expected. These factors, combined with the persistence of significant growth in seriously delinquent borrowers, are leading to upward revisions in loss expectations and a greater likelihood of the realization of these expectations.

“Specifically, the expected losses for the 2005, 2006, and 2007 vintages of subprime collateral have been revised to 8.5 percent, 18.8 percent, and 17.4 percent, respectively, levels meaningfully higher than the 5.75 percent, 15.5 percent, and 17.0 percent levels used in our December 2007 stress test.”

The rating agency added that it “continues to take a negative view of those companies with significant exposure to domestic subprime mortgages and CDOs with subprime RMBS collateral. This view reflects the uncertainty of what the ultimate RMBS and CDO-related losses will be and whether the insurers will be successful in managing their capital positions to handle these losses. Therefore, Standard & Poor’s expects to retain these negative outlooks until the uncertainty surrounding subprime losses can be minimized or eliminated.”

In other words S&P is keeping the ratings door open in the hopes that things may get better. On the other hand they could also get worse.

Source: Standard & Poor’s – www.standardandpoors.com

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