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That Sinking Feeling
By Ted Cornwell
You know times are troubled when the Federal Reserve Board makes an unprecedented, dramatic cut in interest rates, and the stocks of some mortgage-related companies get clobbered anyway.
Chief among the concerns of investors who've been fleeing the mortgage space in recent weeks is loss exposure on huge portfolios of securitized mortgage loans. And ground zero of market discontent is the mortgage insurance firms, which hold the first loss position for low downpayment home loans, and the kin of the MI industry, the bond insurance companies.
In a nutshell, the MI firms generally insure individual home loans or bulk pools of home loans for losses up to 20% of the loan-to-value ratio. That first-loss position makes it possible for homebuyers to pay less than a 20% downpayment and still obtain attractive financing.
The bond insurance firms play a big role in the secondary market, providing "wraps" or insurance on asset-backed securities that improve the execution for issuers by providing a degree of credit support on the bonds. They also play a reinsurance function for companies like the mortgage insurers.
The problem: all the subprime mortgage writedowns have created a headache for bond insurers, including Ambac, MBIA, and FSA. Downgrades and warnings about downgrades affecting those firms has had a ripple effect on the entire market, causing further downgrades of securities backed by home loans. That, in turn, reduces the value of those mortgage-backed securities, causing investors to take big write downs on the value of those holdings.
When Standard & Poor's lowered ratings on $23 billion of home loans last Thursday, concern about the viability of the bond insurance backing the deals was a key factor.
Ambac, the second largest bond insurer, reported a $3.3 billion fourth quarter loss when it released earnings this morning. The company also said it is considering "strategic alternatives." Last week, Fitch cut its credit rating on Ambac. S&P and Moody's are also considering lowering debt ratings on the firm.
Ambac had used subprime mortgage securities as credit derivatives to guarantee other asset-backed portfolios. But the subprime meltdown has diminished market confidence in the value of those assets.
Just to give you an idea of how bad things are at Ambac, the "mark-to-market" losses on Ambac's credit derivatives portfolio amounted to $33.14 per share in the fourth quarter. Ambac's stock was trading at just over $8.00 per share Tuesday morning. (On the bright side, shares were trading up despite the huge loss on hopes that a white knight will come in to bolster Ambac's capital position.)
Ambac's losses related primarily to CDOs backed primarily by "mezzanine level subprime residential" MBS, the company said. The company noted that market prices for CDOs with subprime MBS exposure have fallen dramatically.
The troubles at Ambac, which threaten to overflow into the performance of mortgage insurers as well as Fannie Mae and Freddie Mac, demonstrate how intertwined the fates of mortgage market participants have become. In a world where businesses rely heavily on partners to distribute credit loss exposure, "counterparty risk" is a key concern. Today, the market is weighing that risk more heavily than ever before.
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