CDS Movers

CDS Improvers - 7 February 2008

Ticker	CLIP	Name	Doc Clause	5Y Today	Daily Chg (bp)>	Weekly Chg (bp)	28 Day Chg (bp)
MBI	5A788E	MBIA Inc.	MR	959	-54	-51	66
ABK	0C544C	Ambac Finl Gp Inc	MR	963	-50	-127	99
XL-CapAss	9HBAMG	XL Cap Assurn Inc	MR	915	-48	-19	56
ISYSLN	4A7324	Invensys plc	MM	231	-33	-2	23
MBI-InsCorp	5A78LP	MBIA Ins Corp	MR	376	-27	-72	-35
ABK-AssurCorp	0C54GP	Ambac Assurn Corp	MR	379	-17	-71	-27
JCP	UB78A0	J C Penney Co Inc	XR	226	-11	30	8
MGIC	5A7AC9	MGIC Invt Corp	MR	755	-9	37	239
FKI	GJ87A8	FKI plc	MM	526	-7	-224	80
RAI	7D7884	Reynolds Amern Inc	XR	114	-6	5	22

MBI / ABK / XL-CapAss / MBI-InsCorp - Bond insurers rallied yesterday after MBIA successfully raised $1 billion in equity. The offering was increased from the initial amount of $750 million, with JP Morgan and Lehman Brothers underwriting the plan and private equity firm Warburg Pincus providing a backstop. The new capital will bolster MBIA’s balance sheet and help the operating entity maintain its precious AAA rating. Whether it will be enough to prevent the rating agencies from pulling the trigger remains to be seen. XL Capital Assurance, a smaller rival of MBIA, yesterday saw its AAA financial strength rating downgraded six notches to A3 by Moody’s. XL will now find it difficult to attract new business. Deutsche Bank CEO Josef Ackermann yesterday issued a stark warning about the effects of such negative ratings actions. Ackermann said downgrades on monolines could trigger a “tsunami-like event comparable to sub-prime” as banks take writedowns on their exposure to the sector. Financial spreads will remain volatile until the issue is resolved.

http://www.markit.com/information/news/commentary/cds.html

ISDA Sees Default Swaps Losses at $15 Billion, Not $250 Billion
By John Glover and Hamish Risk

Jan. 22 (Bloomberg) — The International Swaps and Derivatives Association said global losses on credit-default swaps will be nearer $15 billion than the $250 billion forecast by Pacific Investment Management Co.’s Bill Gross.

Losses on the contracts used to protect against the risk a company won’t pay its debt may help push the U.S. economy into recession as corporate defaults rise, Gross said earlier this month. Gross calculated the potential declines by applying the historical average default rate of 1.25 percent to the notional $45.5 trillion of debt that ISDA says is outstanding on credit- default swaps, and then halving the amount to allow for the recovery of 50 percent of the debt.

“Commentators who point to notional values as a measure of market size risk exaggerating potential loss by at least an order of magnitude,” Robert Pickel, the head of New York-based ISDA, which represents 750 banks and securities firms, said in an e-mailed statement yesterday. “Many of these contracts in practice offset each other, as participants constantly adjust their portfolio of risk.”

Credit-default swaps jumped to a record in Europe today on concern falling profits and higher borrowing costs will make it harder for companies to repay debt, according to the benchmark Markit iTraxx indexes. ACA Capital Holdings Inc., the bond insurer being run by regulators because of subprime-mortgage losses, said Jan. 20 it has one month’s grace to unwind $60 billion of credit-default swaps that it can’t pay.

Global Market

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

ISDA said in April that the global market for credit- defaults swaps more than doubled for the third year running. Trading isn’t subject to the same regulations as stocks or bonds because the market is conducted over the counter, or outside exchanges.

Banks and other investors hold overlapping contracts and their net risk is less than $1 trillion, said Pickel, citing industry surveys. Banks are net buyers of protection and insurance companies are the sellers, according to Pickel.

If 2 percent of companies linked to credit-default swaps fail to pay their debts and there’s a 25 percent recovery rate “you might see an aggregate $15 billion of losses on the books of protection sellers,” Pickel said.

“Clearly, while $15 billion is not a trivial sum, it is a small fraction of the aggregate industry write-offs to date on loans and securities,” he said. “It is less than a tenth of some numbers posited for potential settlements in credit derivatives.”

`Egregious Offenders’

Gross was named fixed-income manager of the year in 2007 by Chicago-based Morningstar Inc. His $112.7 billion Pimco Total Return fund returned 9.07 percent last year, in the 94th percentile, Bloomberg data show.

“The $45 trillion CDS market obviously includes many positions which have to be netted out and which are hard to calculate,” Gross wrote in an e-mailed response to ISDA’s comments today. But with the “losses sloshing from one side of the boat to the other,” the net sellers of default protection will be “experiencing huge losses and potential liquidation of their firms.”

Gross described credit-default swaps in his Jan. 8 commentary on Pimco’s Web site as “perhaps the most egregious offenders” in today’s banking system. The market “craftily dodges the reserve requirements of traditional institutions and promotes a chain letter, pyramid scheme of leverage, based in many cases on no reserve cushion whatsoever.”

While there will also be winners among investors that bought credit-default swaps, “the losers in many cases will not be back for a return match,” Gross wrote.

To contact the reporter on this story: John Glover in London at johnglover@bloomberg.net

Last Updated: January 22, 2008 05:07 EST

http://www.bloomberg.com/apps/

news?pid=20601103&sid=aXd._g3cfDXw&refer=news

Default Fears Unnerve Markets

Partners in Credit Deals
Face Big Write-Downs
As Bond Insurer Teeters

By SUSAN PULLIAM and SERENA NG
January 18, 2008; Page A1

The turmoil on Wall Street is beginning to rock a foundation of the financial system: the ability of institutions to make good on their many trades with one another.

Today, a struggling bond insurer, ACA Financial Guaranty Corp., will ask its trading partners for more time as it scrambles to unwind more than $60 billion of insurance contracts it sold to financial firms but can’t fully pay off, according to people familiar with the matter. The contracts were intended to protect Wall Street firms from losses on mortgage securities and other debt they own.

The problem is that the insurer itself is teetering — with repercussions across the financial world. Some of its trading partners, called counterparties, already are writing off billions of dollars because of its inability to pay.

Yesterday Merrill Lynch & Co. wrote down $3.1 billion on debt securities it had tried to hedge through ACA insurance contracts, as part of a larger Merrill write-down. Earlier this week, Citigroup Inc. set aside reserves of $935 million to cover the likelihood that trading partners won’t make good on trades in this market. Such risk helped pummel the stock market yesterday as well.

At the center of these concerns is a vast, barely regulated market in which banks, hedge funds and others trade insurance against debt defaults. This isn’t like life insurance or homeowners’ insurance, which states regulate closely. It consists of financial contracts called credit-default swaps, in which one party, for a price, assumes the risk that a bond or loan will go bad. This market is vast: about $45 trillion, a number comparable to all of the deposits in banks around the world.

Not everyone who buys one of these contracts has bonds to insure; because the value of an insurance contract rises or falls with perceptions of risk, some players buy them just to speculate. In much the way gamblers make side bets on football games, a financial institution, hedge fund or other player can make unlimited bets on whether corporate loans or mortgage-backed securities will either strengthen or go sour.

If they default, everyone is supposed to settle up with each other, the way gamblers settle up with their bookies after a game. Even if there isn’t a default, if the market value of the debt changes, parties in a swap may be required to make large payments to each other.

This being Wall Street, the investors often use heavy borrowing to magnify their wagers.

Relying on Strangers

With many bond values falling and defaults rising, especially in the mortgage arena, some institutions involved in these trades are weakened. This has investors and regulators worried that, through such swaps, some market players could spread their own problems to the wider financial system.

“You are essentially counting on the reliability of strangers” to pay up on their contracts, notes Warren Buffett, the Omaha billionaire. In some cases, he says, market players can’t determine whether their trading partners have the ability to pay in times of severe market stress.

The issue is raising broader concern among regulators and investors over what Wall Street calls “counterparty risk,” the danger that one party in a trade can’t pay its losses. A recent survey by Greenwich Associates found that 26% of investors were worried about counterparty risk, nearly double those who said so in a poll last March.

Federal Reserve Chairman Ben Bernanke, testifying before Congress yesterday, noted that “market participants still express considerable uncertainty about the appropriate valuation of complex financial assets and about the extent of additional losses that may be disclosed in the future.” He said bad financial news has the potential to limit the amount of credit available to households and businesses.

Banking regulators have focused on counterparty risk amid the boom in credit derivatives, instruments whose value depends on the value of some other asset. But they’ve concentrated mainly on banks that service the instruments and on hedge funds that actively trade them — jawboning to try to ensure that trades are properly documented. Few envisioned a little-known bond insurer like ACA causing so much instability.

This market poses challenges for would-be regulators. It isn’t clear, for instance, how securities laws on fraud and insider trading would apply to credit-default swaps, because it’s not clear in what way they are even securities; they are private contracts.

The LTCM Scare

This isn’t the first time the financial world has shuddered at counterparty risk. In the spring of 2005, the downgrading of General Motors Corp. and Ford Motor Co. bonds to “junk” status led to losses for hedge funds that had bought exposure to these bonds through credit-default swaps.

A far bigger problem came in 1998, when the big hedge fund Long Term Capital Management nearly collapsed. Regulators scrambled to arrange an industry bailout, fearing broad damage to the world financial system if LTCM couldn’t make good on billions of dollars of trades with others.

The LTCM crisis involved just one fund, enabling regulators to track its scope quickly. It’s possible that as in the LTCM and auto-bond instances, the markets will soon stabilize without further trouble. But the landscape today is more complex. Traders increasingly sell their credit-risk commitments to other investors in multiple layers, making it difficult to know where the risk ultimately resides.

One hedge-fund manager who has entered into credit-default swaps with 10 brokerage firms says he also has bought such contracts from other market players on the brokerage firms themselves — guarding against the possibility they might not be able to pay.

The market for swaps has grown fivefold just since 2004. It has no publicly posted prices; the contracts are sold privately among dealers. The market began 12 years ago with insurance against defaults on corporate bonds, expanding in 2005 to mortgage securities.

ACA’s Story

The troubles at ACA show how one spark can set off a brushfire. Launched 11 years ago by H. Russell Fraser, a former chief executive of Fitch Ratings and bond insurer Ambac Assurance, ACA originally set out to provide traditional insurance on municipal bonds.

ACA had just a single-A financial-strength rating — not the top triple-A rating of larger players Ambac and MBIA Inc. — and it insured municipal bonds whose own ratings were even lower. ACA promised to cover these bonds’ interest and principal payments on the off chance that city power authorities, schools and other issuers couldn’t make those payments.

It was a steady business but had limited growth. In 2000, ACA moved into the more lucrative arena known as “structured finance.” Initially, it began pooling highly rated securities into bundles called collateralized debt obligations, and managed them for a fee. ACA later began writing insurance on securities backed by corporate and mortgage debt, by selling credit-default swaps.

Investment banks paid ACA annual fees for bearing the risk in their debt securities. This shielded them from the impact of market-price fluctuations, so the banks didn’t have to reflect such fluctuations in their earnings reports.

As long as ACA kept its single-A rating, the banks didn’t require ACA to post collateral even if the securities it insured slipped in value. It’s different if a hedge fund, which doesn’t have a credit rating, is selling the insurance. In that case, each time the security insured falls in value, the hedge fund may be asked to put up more collateral.

Who Owes What

Sometimes it isn’t clear who owes what. A tiny hedge fund sold a swap to a unit of Wachovia Corp. this spring and faced repeated demands for more collateral as the subprime market slid. The fund, CDO Plus Master Fund Ltd., says in a suit in New York federal court that it insured a $10 million security, but Wachovia eventually demanded more than $10 million of collateral — even as the security’s value dwindled. Wachovia called the suit “without merit.”

Last fall, with the market for low-end subprime mortgages collapsing, investors worried about firms with exposure to them. Analysts zeroed in on ACA and other bond insurers that had assumed the risk on many such securities.

ACA appeared to be in the most precarious position, because its capital of $425 million seemed minuscule compared with the $69 billion of credit protection it had provided on corporate and mortgage debt. ACA had added about $20 billion of that exposure between April and September.

The firm was upbeat. ACA Financial Guaranty “has never been in better financial condition,” said Ted Gilpin, chief financial officer of parent company ACA Capital Holdings Inc., in a Nov. 8 conference call with investors. He cited a 67% year-over-year jump in the unit’s third-quarter net profit.

Still, the parent firm reported an overall net loss of $1 billion because of charges from a drop in market value of the mortgage securities to which it was exposed. CEO Alan Roseman brushed off investor worries about the health of financial guarantors, saying clients “have been overfed with fiction from others,” according to a transcript of the call.

The next day, Standard & Poor’s said it was reviewing ACA’s single-A rating for a possible downgrade because the weak earnings report could make it hard for ACA to win new business. ACA executives realized that if their credit rating was cut, the firm might have to post at least $1.7 billion in collateral to its 29 counterparties — cash it didn’t have. They began talking to these parties about how to address the issue. ACA Capital’s shares, which had traded at $15 in June, sank to 50 cents in mid-December and were delisted by the New York Stock Exchange.

On Dec. 19, S&P slashed ACA’s credit to the deep “junk” rating of triple-C — a rude shock not only to ACA but to its bank counterparties. ACA executives were furious with S&P, whose action effectively is putting the company out of business, according to people familiar with the matter. For the banks, the downgrade made the billions of dollars in insurance contracts ACA had provided all but worthless.

Waiving Collateral Demand

That evening, ACA said it had reached a “forbearance agreement” with counterparties, who temporarily waived their right to demand that it post collateral to its swap contracts. The agreement is set to expire today, but ACA is likely to announce an extension to give it more time to work out arrangements with each party, say people familiar with the matter.

ACA is attempting to unwind its swap agreements in an orderly manner, these people add. One possibility: a rescue plan giving the counterparties stakes in a restructured bond-insurance company. An alternative plan or capital infusion is also being considered, the people add. It’s a tenuous position: ACA needs the cooperation of all counterparties to avoid collapse.

A few of its trading partners — not just Merrill but also Canadian Imperial Bank of Commerce and French securities firm Calyon Securities — recently reported write-downs on the ground that ACA wasn’t likely to be able to continue protecting them from losses on mortgage securities. CIBC’s write-down is $2 billion and Calyon’s is about $1.7 billion. Lehman Brothers Holdings Inc. and Bear Stearns Cos. also have small exposures to ACA.

Merrill CEO John Thain says counterparty risk at his firm is limited to ACA. But ACA isn’t the only insurer with a problem. Last month, Structured Credit Co., a small Dublin insurer, completed a plan that will pay its dozen trading partners just 5% of what they are owed. Its problems leave various financial firms with losses totaling about $250 million.

Investors, banks and regulators are also concerned about bigger bond insurers. Moody’s said this week it may cut the top ratings on MBIA and Ambac.

Bill Gross, chief investment officer at Allianz SE’s Pacific Investment Management Co, or Pimco, recently told investors that if defaults in investment-grade and junk corporate bonds this year approach historical norms of 1.25% (versus a mere 0.5% in 2007), sellers of default insurance on such bonds could face losses of $250 billion on the contracts. That, he said, would equal the losses some expect in the subprime-mortgage arena.

With no central trade processing of credit-default swaps, defining trading-partner risks can be a Herculean task. Mr. Buffett learned the difficulty of unraveling such complex instruments in 2002 when he directed General Re Corp., a reinsurer that had been acquired by his Berkshire Hathaway Inc., to pull back from the business of these swaps and other derivatives. It took General Re four years to whittle the business from 23,218 contracts to 197 by the end of 2006.

Doing so involved tracking down hundreds of counterparties to General Re’s trades, many of which Mr. Buffett and his colleagues had never heard of, he says, including a bank in Finland and a small loan company in Japan, to name just two. One contract, Mr. Buffett says, was designed to run for 100 years. “We lost over $400 million on contracts that were supposedly” safe and properly priced, “and we did it in a leisurely way in a benign market,” Mr. Buffett says. “If we had to unwind it in one month, who knows what would have happened?”

Write to Susan Pulliam at susan.pulliam@wsj.com and Serena Ng at serena.ng@wsj.com

 http://online.wsj.com/article/SB120061980722699349.html?mod=mostpop

MBIA Skids on CDO Disclosure

By ROMY VARGHESE
December 20, 2007 2:46 p.m.

NEW YORK — Confidence in top bond insurer MBIA Inc. plummeted Thursday after the guarantor disclosed on its Web site that it had $8.1 billion in exposure to complex and risky securities backed by home loans.

The insurer said these collateralized debt obligations are backed by high-grade debt, with 85% of the collateral from other CDOs.

Markets sent the company’s stock lower and the cost of protecting MBIA debt soaring, with a Morgan Stanley note on the disclosure fueling concerns that the bond insurers’ troubles are deeper than originally thought.

Morgan Stanley analysts led by Ken A. Zerbe, known for his bearishness on the bond insurers, said MBIA’s $8.1 billion of exposure to these securities, called CDO-squared transactions, is “massive.”

MBIA shares Thursday sunk as far as $18.84, which represented the lowest mark for MBIA stock since January 1995. In late morning trade, the stock was off 22% at $20.96.

MBIA and its rival Ambac insure more than $1 trillion of securities. Their exposure to subprime-related investments and other risky securities has cultivated doubts on whether their capital cushions are sufficient to absorb potential losses and retain their top triple-A rated status.

If they lose their top ratings, it would ignite a repricing of all the bonds they insure and raise questions over the future of the industry itself.

That has led these once-overlooked companies have caused a storm in financial markets in recent months, with their stocks and credit default swaps — derivatives which measure the cost of protecting the company’s debt — to swing violently, as each piece of potentially worrisome news hits the markets. Analysts and investors have expressed frustration at not being able to gauge how much exposure these insurers have to subprime mortgages that have gone bad.

Mr. Zerbe said MBIA’s exposure to CDO-squareds hadn’t been released before. “We are shocked that management withheld this information for as long as it did,” he said.

The company didn’t return a call for comment Thursday morning.

S&P, which on Wednesday affirmed MBIA’s triple-A rating with a negative outlook, said Thursday its decision incorporated MBIA’s $8.1 billion CDO-squared exposure, as well as the $30 billion in total CDO exposure.

MBIA said on its Web site that it “supplemented the listing of its exposure to CDOs that include RMBS (residential mortgage-backed securities) as of Sept. 30, 2007 to make it consistent with the CDOs that were included in Standard & Poor’s analysis.”

On Wednesday, the credit and stock markets had a more muted reaction to the S&P report. Credit defaults swaps, which also serve as a barometer of investor confidence, widened only slightly and share prices dipped.

Moody’s Investors Service last Friday also affirmed MBIA’s rating with a negative outlook, while giving Ambac’s triple-A rating a stable outlook. That had puzzled several analysts at the time.

“We had originally questioned how Moody’s and S&P could have taken a more negative view of MBIA than Ambac,” Mr. Zerbe said. “Now we know — MBIA simply did not disclose arguably the riskiest parts of its CDO portfolio to investors: $8.1B of CDO-squareds.”

T.J. Marta, strategist at RBC Capital Markets, said Thursday that until now, Ambac and ACA Financial Guaranty Corp, which was cut by S&P from single-A to triple-C Wednesday, were considered the market’s biggest worries.

“The notion of the CDO squared just spooked everybody this morning,” he said.

Of the slew of analysts’ reports, Morgan Stanley’s was the most negative. Ambac last month criticized a Morgan Stanley report on its firm as not accurately reflecting the situation faced by the insurer.

JP Morgan analysts on Thursday targeted the ratings agencies in their note. The S&P and Moody’s reviews raise more questions and have “doled out slaps on the wrists,” they said.

“We feel S&P and Moody’s are merely sweeping the potential for significant future losses under the rug, hoping for the best and discounting the worst,” they wrote.

Fitch Ratings has yet to release its updated reviews of MBIA and Ambac, which are expected later this week.

The credit default swaps for the MBIA triple-A rated insurance unit widened by 70 basis points to 320 basis points. That means the annual cost of protecting a notional $10 million of its bonds against default for five years is now $320,000 versus $250,000 earlier.

For the double-A rated holding company, the CDS are 100 basis points wider at 600 basis points, according to a market participant.

 

–Emily Barrett and Cynthia Koons contributed to this report.

Write to Romy Varghese at romy.varghese@dowjones.com

http://online.wsj.com/article/SB119816537649342533.html?mod=hpp_us_whats_news

 

Bond Insurer’s Stock Plunges on Exposure

 

 

 

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By REUTERS

Published: December 20, 2007

MBIA said Thursday that it has exposure to $30.6 billion of collateralized debt obligations it insures, including a large exposure to risky bonds known as CDO squared, sending its stocks plummeting 22 percent in early trading.

 

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MBIA said in a statement released on its Web site on Wednesday that it has exposure to $30.6 billion of total CDOs net par that it insures. MBIA, the world’s largest bond insurer, also is vulnerable to $8.1 billion of CDOs backed by high-grade collateral, 85 percent of which are risky bonds known as CDOs of CDOs, or CDO squared.

“We are shocked that management withheld this information for as long as it did,” said a report from Morgan Stanley , referring to the CDO-squared exposure.

“This new disclosure completely changes our view of MBIA being a ‘more conservative underwriter’ relative to Ambac,” said the Morgan Stanley report, which was written by two analysts, Ken Zerbe and Yoana Koleva.

Ambac is the second-largest bond insurer behind MBIA.

http://www.nytimes.com/reuters/business/reuters-mbia.html?_r=1&oref=slogin

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Bond insurers

Published: December 20 2007 19:00 | Last updated: December 20 2007 19:04

MBIA gets top prize for understatement. When an insurer delicately refers to “supplementing” its list of collateralised debt obligation exposures, that can only be bad news. It is. It turns out that MBIA has an $8bn exposure to CDOs of CDOs (or so called “CDOs-squared”).

This is a critical nugget of information, to which the market had an allergic reaction, sending MBIA stock down 25 per cent on Thursday. CDOs-squared are scary because they compound the leverage and complexity of original CDOs, already in the dog house. MBIA can claim that the collateral in the “inner” CDOs is overwhelmingly AAA and AA. Nobody is listening. Markets have had enough of supposedly armour-plated securities tanking.

 

 

EDITOR’S CHOICE

 

Fears mount over bond insurers - Dec-20

 

MBIA gets $1bn injection from Warburg - Dec-10

Investors will be wondering how this news affects MBIA’s crucial capital raising with private equity firm Warburg Pincus. All credit market participants have an interest in the answer to that question. If MBIA’s capital position is not strengthened sufficiently, the rating agencies could have another go at reviewing the credit rating. A downgrade would hit all the securities MBIA insures, including the vast municipal market. Happy holidays.

http://www.ft.com/cms/s/1/e04ab97a-af2c-11dc-880f-0000779fd2ac.html

MBIA Tumbles on $8.1 Billion of CDOs, Fitch Warning (Update8)
By Shannon D. Harrington and Christine Richard

Dec. 20 (Bloomberg) — MBIA Inc. fell the most since 1987 in New York trading after the world’s biggest bond insurer disclosed that it guarantees $8.1 billion of collateralized debt obligations that investors say have a greater chance of losses.

“We are shocked management withheld this information for as long as it did,” Ken Zerbe, an analyst with Morgan Stanley in New York, wrote in a report yesterday. “MBIA simply did not disclose arguably the riskiest parts of its CDO portfolio to investors.”

MBIA, Ambac Financial Group Inc., and other insurers are being reviewed by credit-rating companies on concern they don’t have enough capital to cover potential losses stemming from mounting downgrades of the securities they guarantee. Fitch Ratings ratcheted up the pressure on MBIA today, saying it would reassess its AAA insurance rating for a possible downgrade and gave the company four to six weeks to raise at least $1 billion.

More than $2 trillion of insured securities would lose their AAA ratings amid mass downgrades of bond guarantors. MBIA fell $7.07, or 26 percent, to $19.95 at the close of regular New York Stock Exchange trading. Ambac rose 24 cents to $27.70.

MBIA posted a document on its Web site late yesterday showing it insured $8.1 billion of so-called CDOs-squared, which repackage other CDOs and securities linked to subprime mortgages. Rising delinquencies on subprime loans contributed to downgrades on 2,007 CDOs last month alone, according to Morgan Stanley.

The “eleventh-hour” disclosure by MBIA “ignites concerns all over again about the prospect for future losses,” Kathleen Shanley, an analyst at bond research firm Gimme Credit in Chicago, wrote in a report. She said outside investors didn’t know about the CDOs-squared, which she called the riskiest type of CDO.

Shattered Confidence

The disclosure followed Standard & Poor’s decision yesterday to lower its outlook to negative for the AAA ratings of the bond insurance units of Armonk, New York-based MBIA and Ambac. Calls to Elizabeth James, a MBIA spokeswoman, weren’t returned.

The $30 billion of exposure for MBIA Insurance to CDOs linked to residential mortgage-backed securities that S&P listed in its report yesterday includes the CDOs-squared disclosed by MBIA, S&P said today in response to investor inquiries. A Dec. 14 analysis by Moody’s also included the exposures, Jack Dorer, an analyst at the New York-based ratings company, said in an e-mail message.

“How is confidence expected to return to the capital markets when these types of surprises continue to pop up?” said Peter Plaut, an analyst at New York-based hedge fund manager Sanno Point Capital Management.

Bond Risk

Credit-default swaps for MBIA soared as much as 145 basis points to 625 basis points, the widest ever, before narrowing to 568 basis points, according to prices from CMA Datavision in London. That means it costs $568,000 a year for an investor to protect $10 million in MBIA bonds from default for five years.

One-year contracts surged to 1,050 basis points, prices from broker Phoenix Partners Group show. That implies investors are pricing in a 20 percent chance of default by March 2009, according to a JPMorgan Chase & Co. valuation tool used by Bloomberg.

Contracts on MBIA’s bond insurer, MBIA Insurance, climbed 55 basis points to 300 basis points after reaching 340 basis points earlier today, CMA prices show. Contracts tied to Ambac rose 17 basis points to 582 basis points, according to CMA.

Potential losses from the CDOs-squared are “hardly the kind of hit that should cause severe spread widening or the stock to crash,” Barclays Capital credit analyst Seth Glasser said in a note to clients today. He said the CDOs MBIA disclosed yesterday may be less risky than investors are betting.

The Markit CDX North America Investment Grade Index, a benchmark credit-default swap index linked to the bonds of 125 companies including MBIA Insurance, rose 1 basis point to 78.5 basis points, according to Deutsche Bank AG in New York.

Warburg Pincus Investment

Fitch’s rating review on MBIA is more aggressive than actions by Moody’s and S&P. Both of those companies affirmed MBIA’s AAA insurance rating with a negative outlook. Moody’s and S&P also didn’t set a deadline for MBIA to raise additional capital.

Fitch cited deterioration on some of the $22 billion of securities MBIA insures that are backed by second-lien mortgages. MBIA announced last week it was setting aside $500 million to $800 million to cover expected claims on those bonds.

On Dec. 10, MBIA said Warburg Pincus LLC agreed to purchase $500 million of new shares at $31 each and to “backstop” a private placement rights sale for an additional $500 million in an effort to bolster capital. Three days later, MBIA in a regulatory filing said the deal was contingent on performance-specific covenants and referenced a schedule of undisclosed conditions.

It’s unclear if Warburg Pincus knew about the CDOs-squared, which could imperil the investment, Shanley said. Chuck Dohrenwend, a Warburg Pincus spokesman, declined to comment.

Stress Test

S&P ran a stress test to determine the losses bond insurers would take on securities backed by subprime mortgages, including CDOs. Losses were projected at $3.1 billion for MBIA, $1.8 billion for Ambac, and $2.2 billion for Financial Guaranty Insurance Co.

MBIA’s higher loss potential was attributed to the company’s guarantees on securities backed by home equity loans, S&P said.

MBIA Insurance stands behind about $652 billion of municipal and structured finance bonds. Ambac insures $546 billion of debt.

MBIA’s disclosure explains why S&P and Moody’s Investors Service turned more negative on the industry in recent weeks, Zerbe said. Last month, Moody’s said MBIA was “unlikely” to fall below its target capital level for an AAA bond insurer despite downgrades of securities backed by subprime mortgages. Ambac had been flagged as “moderately” likely to need more capital.

“This disclosure completely changes our view of MBIA being a more conservative underwriter relative to Ambac,” Zerbe wrote.

CDOs have accounted for the biggest portion of the more than $70 billion in writedowns in the past two quarters at the world’s biggest banks. CDOs-squared have lost the most on a percentage basis among CDOs linked to subprime mortgages, New York-based Merrill Lynch & Co.’s third-quarter disclosures showed.

To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net ; Christine Richard in New York at crichard5@bloomberg.net .

Last Updated: December 20, 2007 18:12 EST

http://www.bloomberg.com/apps/news?pid=20601009&refer=bond&sid=a2urvXPUbjB4

 

Credit default swaps are a type of credit derivative in which a holder of debt, such as a mortgage-backed bond or a corporate bond used to finance a leveraged buyout, purchases coverage in the form of a CDS contract from a third party against the possibility that the debtor will default. By allowing sellers to take on, or buyers to reduce, the risk of default on a bond, swaps are meant to more evenly spread risk throughout financial markets.

Tuesday, September 4, 2007

The Pros: They allow debt holders to hedge against the risk that the people or institutions paying off the debt will fail to meet their loan obligations. They also allow investors to essentially place bets on whether they believe a default is likely.

The Cons: The sellers of this protection are often hedge funds, who may be losing money at the same time they are selling the protection, leaving them unable to honor their commitments. The market for CDS contracts is also relatively new, so its ultimate impact on financial markets overall is still unknown.

The Context: The cost of a CDS contract varies depending on the level of risk that a borrower will be unable to make a payment, and the shaky condition of credit markets earlier this summer sent demand for credit insurance so high that many banks were challenged to keep up with it. Contracts written on investment banks such as Bear Stearns and Goldman Sachs Group soared. Concern that troubles in the subprime-mortgage market and the leveraged-buyout market could damage its balance sheet at one point more than quadrupled the cost of a five-year contract for $10 million on Bear Stearns. –Compiled by: James Willhite

Soaring Swaps

Source: Credit Derivatives Research

WSJ Links

• LBO Shops Drove Debt Boom; Now, They Profit From Its Fall

• Default Swaps Could Magnify Credit Crisis

• A New World of Disorder for Debt Traders

• Insuring Against Credit Risk Can Carry Risks of Its Own

CDS Report: Chrysler snapped up at the gates of hell

Cereberus, the US private equity firm named after the mythical dog that guards the gates of hell, took a chunk out of DaimlerChrysler Monday by agreeing to buy a majority stake in its struggling US-based Chrysler operations for $7.4bn.

The news made the German parent of the carmaker one of the biggest movers in European credit derivatives markets in morning trading by improving the outlook for its credit quality without the burden of US operations.

Traders sent the cost of protection against default on Daimler’s debt down by about €7,000 per year on the five year contract to about €25,500 for €10m worth of bonds.

The fall in the premium on the company’s credit default swaps, which provide a kind of insurance against non-payment of corporate debt, shows that traders see the move as reducing the likelihood that the German group will ever default on its debt. However, the sale, which ends Daimler’s nine-year adventure in the US, will initially cause some pain as the company will itself receive only €1bn of the sale price and will see net profits hit by €3bn-€4bn due to the sale in 2007.

Elsewhere, the cost of protection on Clariant continued to rise due to speculation about a possible private equity bid for the Swiss speciality chemicals company, even though its shares fell following an announcement on Friday from the group that it had not received any takeover approach.

Another rise in the group’s CDS spread by about 5bp to about 57bp suggests traders in the credit derivatives markets think they know something the company doesn’t.

Morrison, the UK supermarkets group, also saw a rise early on due to private equity speculation, however, the spread later retrenched after a counter-rumour saying that CVC was not looking at the company.

In the indices, the iTraxx Crossover index of mainly junk-rated names, which acts as the bellweather for risk appetite in the markets, cheapened to break the important 200bp barrier Monday morning on the back of stronger equity markets.

The cheapening of credit risk premiums had been decoupled from equity market strength recently, according to some analysts, in part because a lot of the stock market gains were seen as coming from private equity interest rumours, which is generally seen as bad for bond holders.

However, the credit bulls have begun to get their way again, driving the cost of protection on the Crossover down to about 199bp at the open.

http://ftalphaville.ft.com/blog/2007/05/14/4499/cds-report-chrysler-snapped-up-at-the-gates-of-hell/

No surprise the exchange trading is thin. These contracts should not be so standardized, makes little sense for the non-speculative insurability component of the CDS even if speculators might enjoy a free ride via the Eurex.

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Credit Derivatives Flop on Exchanges; Dealers Boycott (Update2)

By Shannon D. Harrington

April 17 (Bloomberg) — The world’s biggest futures and options exchanges are failing to break Wall Street’s hammerlock on credit-default swaps, the world’s fastest-growing financial market.

Three weeks after Eurex AG, Europe’s biggest futures exchange, introduced the first contracts that allow investors to bet on a company’s ability to pay its debt, 253 million euros ($343 million) have changed hands. Banks including JPMorgan Chase & Co., Citigroup Inc. and Goldman Sachs Group Inc. trade about 15 billion euros of credit-default swaps each day, according to data compiled by Frankfurt-based Deutsche Bank AG.

The banks are refusing to trade the Eurex contracts, heading off competition in a market that doubled to $294 billion in the year ended in June, according to the Bank for International Settlements in Basel. The Chicago Mercantile Exchange, the biggest U.S. futures exchange, and the Chicago Board Options Exchange, the biggest U.S. options markets, expect a similar reception when they introduce credit derivatives this year.

“The dealer community is not really supporting this,” said Joe Levin, the CBOE’s vice president of research and product development in Chicago.

Credit-default swaps, conceived more than a decade ago by bankers in New York and London as a way to protect lenders against default, now are used by hedge funds and investors as a less expensive way of betting on the creditworthiness of companies than purchasing bonds.

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should the company fail to keep to its debt agreements. A drop in the cost of the contracts indicates an improved perception of credit quality.

Keeping a Stranglehold

Banks and securities firms are keeping a stranglehold on the market, which has swelled to cover debt sold by more than 3,000 companies, governments and industries.

JPMorgan and Citigroup, both based in New York, and Bank of America Corp. in Charlotte, North Carolina, handled about 90 percent of the $9 trillion in credit derivatives trades in the fourth quarter among U.S. commercial banks, the U.S. Office of the Comptroller of the Currency in Washington said.

Bear Stearns Cos., also in New York, said in March that credit derivatives helped push net revenue in its fixed-income unit to a record $1.1 billion last quarter, 27 percent higher than a year earlier.

`A Fizzle, Not Bang’

The International Swaps and Derivatives Association’s 22nd annual conference, which begins today in Boston, features as its keynote speakers European Central Bank President Jean-Claude Trichet and Bank of America Chief Executive Officer Kenneth Lewis. None of the exchanges are on the group’s list of exhibitors or speakers. The Merc, CBOE and Euronext.liffe, Europe’s second-largest derivatives exchange and a unit of New York-based NYSE Euronext, had booths at past conferences.

Societe Generale SA is the only one of the 20 biggest banks in credit-default swaps to trade the new contracts offered by Frankfurt-based Eurex. Bloomberg LP, the parent of Bloomberg News, provides the pricing model to calculate the settlement prices of the Eurex contracts.

“Their introduction seems to have gone off with more of a fizzle than a bang,” said Simon Surtees, co-head of fixed income at Gartmore Investment Management in London, who helps manage about $3.6 billion of corporate bonds and credit-default swaps.

Exchanges, which have traded futures and options on bonds and interest rates for more than a decade, said four years ago that they planned to penetrate the credit derivatives markets.

Offering Contracts

The exchanges are “pretty late to the game,” said Jeff Lenamon of Diversified Credit Investments in San Francisco. “They should have done that six or seven years ago. Most people are pretty happy with how the credit derivatives market works.”

The Singapore Exchange Ltd., which runs that country’s securities and derivatives market, became the first bourse to announce plans for credit-default swap trading in December 2003. It still doesn’t list any of the contracts.

Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.

Eurex and the Chicago markets want to offer contracts on indexes created by banks that track credit-default swaps. Dealers have created four indexes in the U.S. and three in Europe. In the U.S., they are known as CDX and in Europe they are called iTraxx.

Eurex is giving investors the ability to bet on gains and losses in three iTraxx indexes, one for investment-grade companies, one for companies that straddle the line between investment-grade and high-risk, high-yield and one that includes the riskiest investment-grade companies. The contracts mature every five years, with new futures issued every six months.

Boycotting the Contracts

Banks are boycotting the contracts. New York-based ISDA, which represents 750 institutions, said last month it was investigating whether the contracts could “adversely” influence bond prices.

“The contracts are flawed,” Guy America, JPMorgan’s European head of credit trading in London, said in a March 29 interview. “It’s my understanding that one in 20 futures contracts are successful and this may become one of the 19.”

Eurex says the futures contracts will make it easier for all market participants, including banks, to trade corporate credit.

“Not all the banks are being helpful,” said Eurex spokesman Heiner Seidel in Frankfurt. “It’s not obvious to us that our product will take business away from the banks. We can add liquidity to the whole market.”

The Chicago Merc, which plans to start offering a futures contract modeled after the CDX indexes on May 6, has yet to name market-makers. NYSE Euronext and the Chicago Board of Trade also are planning to enter the market.

`Logical Benchmark’

“Clearly, the CDX is the dominant index in the U.S.,” said Robin Ross, a managing director at the Chicago Merc. “That would be the logical benchmark.” The exchange wouldn’t discuss its conversations with the index owners.

CDS IndexCo LLC, the group of 16 banks that own the CDX indexes, declined to comment on discussions with the exchanges, said spokesman Michael Mandelbaum in Los Angeles.

JPMorgan, Morgan Stanley, Goldman Sachs and the 13 other dealers that own the benchmark credit-default swap indexes haven’t granted licenses to the U.S. exchanges for their contracts. None of the banks that own the CDX indexes has agreed to buy and sell the contracts the CBOE may start trading next month, the CBOE’s Levin said. Morgan Stanley and Goldman Sachs are based in New York.

“We’re offering a standardized product that’s going to be transparent,” said Levin, who said the exchange may start offering its credit options next month. “They do it over-the- counter in an opaque, non-transparent way.”

Falling Profit Margins

The banks have seen profit margins fall when they make prices easier to find and markets more transparent. Earnings from trading corporate bonds tumbled after the National Association of Securities Dealers in 2002 required traders to post details of bond transactions on a centralized computer system known as the Trade Reporting and Compliance Engine.

The difference between bids to buy and offers to sell corporate bonds narrowed by about half, or 8 basis points, in the first year after the July 2002 introduction of Trace, representing $1 billion in lost commissions, according to Kumar Venkataraman, a professor at Southern Methodist University in Dallas, who teaches portfolio management at the Edwin L. Cox School of Business. A basis point is 0.01 percentage point.

“I don’t believe that the liquidity will be better on the exchanges,” said Jeffrey Kushner, a managing director at New York-based BlueMountain Capital Management LP, which manages about $3.1 billion. “The hedge fund community, especially those that trade credit derivatives as a core product, isn’t going to use this product, nor the banks.”

Too New

Eurex executives say the contracts are too new to be written off. They wrote to investors this week to respond to concerns.

“The first days of trading are not an indication of the success or failure of the product,” said Seidel of Eurex. “We believe in the potential of the product, especially in light of the interest we’ve seen from the buy-side.”

A survey of investors by New York-based Merrill Lynch & Co. suggested trading in the Eurex credit futures may pick up. More than 80 percent of those polled said they plan to trade the contracts. Almost a third wanted to trade them because they couldn’t trade credit-default swaps in the private market.

“We’d be willing to look at any of these products that make sense from a liquidity and pricing perspective, but we think it will be some time before that develops in any of these products,” said J.J. McKoan, who oversees about $60 billion in assets as director of global credit at AllianceBernstein LP in New York.

Biggest Problem

The biggest problem for the U.S. exchanges is how the contracts work, said David Boberski, head of U.S. interest-rate strategy in New York at Bear Stearns and the author of “Valuing Fixed Income Futures.” (McGraw-Hill, 304 pages, $75)

The values of credit-default swaps created by dealers are partly derived from an estimate of what the buyer would recover in the event of a bankruptcy. The recovery rates vary from company to company, and industry to industry.

The Merc says its futures contract will have the same expected recovery rate regardless of company or industry. The CBOE’s options will pay a flat rate, not a recovery rate.

“Whenever you create a futures product that has economics that differ from the over-the-counter market, you’re asking traders to make a leap of faith, in this case a $30 trillion leap of faith,” Boberski said in an interview. “They’re asking the over-the-counter market to remake itself in the image of the exchange, and it will never happen.”

Even if the first products fail, the exchanges can’t be counted out, Boberski said.

`Potential’ Exists

“The potential for this market is far greater than any of those dealers perhaps even recognize themselves because this market evolved in a time of very low volatility and relatively robust economic growth with few bankruptcies,” he said. “What happens when there are a significant number of bankruptcies? Trading will spike. It makes a lot of sense to have the exchanges as a backstop for those clearing and settlement issues.”

The Chicago Merc’s Ross has a 1982 magazine article pinned to the bulletin board in her office describing the “disappointing debut” of the Eurodollar futures, now the world’s most actively traded futures contract and a popular way to bet on U.S. interest rates.

Ross refers to the article from Institutional Investor whenever skeptics say the Merc, along with the CBOE and Eurex, have little to show for a three-year effort.

“C’mon,” she said. “It takes time.”

To contact the reporter for this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net .

Last Updated: April 17, 2007 12:07 EDT

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