Monolines in a world of pain

In a stunning move, Standard & Poor’s cut the rating on ACA Capital to CCC from A on December 19. At the same time, it put five other monolines on watch negative from their higher ratings. The actions come after widespread concern over the companies’ ability to meet obligations on their highly rated asset-backed securities (ABS) and collateralised debt obligations (CDO) of ABS exposures to the poorly performing US subprime mortgage market.

ACA Capital itself has since announced a forbearance agreement with all its credit counterparties on December 20. Under the terms of the agreement, which remains in place until January 18, all collateral posting and termination rights have been waived.

The problem lies partly with its business model, which ensures a AAA rating with no collateral posting on assets through a high level of subordination.

The two giants of the industry, Ambac and MBIA, have both been forced to go to the markets for further capital. MBIA itself has been at the centre of a storm after a further clarification of its $30.6 billion CDO squared exposure identified an exposure of $8 billion to subprime residential mortgage-backed securities (RMBS) was announced on December 19. The next day, though not as a result of the announcement, Fitch Ratings placed 173,022 securities backed by MBIA on rating watch negative. The company had announced a $1 billion injection of capital from Warburg Pincus on December 10.

Ambac, on the other hand, announced a $29 billion reinsurance deal with monoline insurer Assured Guaranty’s reinsurance arm on December 13. Aside from the issues with passing on a large amount of non-ABS and therefore highly desirable assets to a smaller and better-positioned competitor, the deal was viewed as a quick and positive step by market participants.

The effect of the crisis has put the spotlight on the banks that have counterparty agreements with troubled monolines. CIBC, for example, confirmed on December 19 that it was a hedge counterparty with ACA on $3.5 billion of subprime assets, and expected a charge of $2 billion on the bank’s book for the first quarter. Merrill Lynch is also exposed to $5 billion of agreements with the company in the sector.

This has meant that dealers are reassessing that exposure.

“The crisis of confidence in the monoline sector is likely to change the way banks look at opening credit lines with these companies,” says Alberto Thomas, head of credit structuring at RBS in London. “ My feeling is that some banks are going to start to analyse credit exposure to monolines based on the money goodness of the positions insured and their ability to absorb actual losses rather than the actual mark-to-market of the positions.”

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