Some think the subprime mortgage meltdown will have limited impact. The thing is, that is just not so. The big danger was always that the bond insurers, companies such as Ambac and MBIA, would be downgraded from AAA ratings. Now, why is this important? Because what Ambac and MBIA do, in effect, is sell their AAA rating for the use of borrowers who need to fortify their credit ratings for various projects.
But the subprime situation threw everyone a curve.
It even effects as stodgy an industry as life insurance.
We'll be looking at life insurers' exposure to subprime today, to point out just how far-reaching this debacle in truth is.
Because if financial instruments so poorly correlated to the other markets are impaired by subprime, then imagine all the things in between that are, only more so.
Back in the fall, one inquirer asked the executive team of Genworth about its subprime exposure, and what would happen should the bond insurers be downgraded. From the Fall 2007 Strategic Update Meeting:
SUNEET KAMATH: Related to the first response, if Ambac [and] MBIA do get downgraded, would that further increase your interest cost? Is there a component related to the interest expense that is tied to the ratings of those companies?
DENNIS VIGNEAU: There is. We will have a small uptick in the cost there, about 25 basis points, which on a full-year basis, would amount to about $3 million after-tax.
SUNEET KAMATH: Okay, thanks.
Doesn't sound so bad and Mr. Vigneau did not sound too worried back in the fall.
He's probably worried today. His company's stock is down a fair bit.
Major U.S. bond insurers are in the ratings agency spotlight, and not liking it
Ambac and MBIA are now quite likely to be downgraded
BOSTON (MarketWatch) -- Shares of bond insurers traded sharply lower, retreating Thursday as a ratings agency [Moody's] warned it may downgrade Ambac Financial Group Inc. -- a move that could force the troubled company into bankruptcy.
Shares of Ambac and rival MBIA were down by 60% and 30%, respectively, in early trading. The news also roiled financials stocks since bond insurers guarantee debt held by some of the nation's largest banks.
Earlier this week, Ambac said it will seek to raise at least $1 billion in new capital by selling equity and equity-linked securities. The company also slashed its dividend by two-thirds and announced Robert Genader, was leaving as chief executive.
In addition, the company may raise more capital by selling new debt securities and buying more reinsurance.
Ambac's bailout plan is to issue more debt.
The thing is, rival MBIA tried that last week, offering 14% yield. The notes are selling at a steep discount a week later.
"Rival MBIA raised $1 billion in new capital by selling surplus notes last week. The securities paid an initial interest rate of 14% to attract investors.
But despite that high yield, the notes have slumped this week, according to David Havens, head of investment grade corporate bond research at UBS.
The securities traded below 90 cents on the dollar earlier on Wednesday, weighed down by Ambac's announcement, recession fears and Standard & Poor's decision on Tuesday to increase its mortgage-loss assumptions, Havens explained.
Such weakness could make it more difficult for Ambac to raise money, especially by selling new debt, he added.
Point being, the market is assigning a very heavy risk premium for debt issues for the bond issuers. The other shoe - They may require an "insurer" of their own. The American taxpayer. And we are talking an immense sum of money if that occurs.
In the meantime, both Ambac and MBIA have incurred severe punishment in stock value
to put it mildly
MBIA, the biggest bond insurer, declined 75 percent on concern it may not have enough capital to cover losses on securities it guarantees, including those linked to mortgages. The Armonk, New York-based company dropped 16 percent Dec. 28 after Warren Buffett's Berkshire Hathaway Inc. won a New York state license to start a rival bond insurer.
..
``This could potentially hurt MBIA and Ambac,'' said Rob Haines, an analyst at CreditSights Inc. in New York. Berkshire will ``be a formidable competitor.'' Ambac Financial Group Inc., the second-largest bond insurer, dropped 71 percent in 2007.
Regardless, MBIA is putting out optimistic press. S&P, however, has another opinion per this Forbes article:
NEW YORK - MBIA Inc. said Thursday even after assuming more losses on bad mortgage loans, the bond insurer will still have a strong enough capital cushion to comply with Standard & Poor's Ratings Services' standards for financial strength.
S&P earlier this week said it now expects the loss rate on 2006 "subprime" mortgages - or home loans issued to people with checkered credit histories - will reach 19 percent, versus the ratings agency's previous forecast for losses of 14 percent.
...
MBIA, which insures $673 billion in debt, writes policies promising to cover missed payments by bond issuers.
S&P in December told the company its capital was deficient by $1.4 billion to maintain its top-notch financial-strength rating. A downgrade of MBIA's "AAA" financial-strength rating would harm the company's prospects of winning new business.
Did I mention "immense sums" earlier?
So, How are Ambac's MBIA's stocks doing today?
Not optimally. Ambac is down 52.12% ON THE DAY as of this writing this link
and here's the six-month chart
MBIA not doing so hot either; down 31.94% at time of writing.
another six month chart
Now for why I am interested in the life insurance angle
Life insurance has been opening up as an emerging secondary (freely-traded, more or less) securities market, just as mortgage backed securities began to be in the 1980s. The attractiveness is that the largest risk component is mortality, which is not correlated closely with changes in the capital markets. The thing is, the biggest expense other than paying claims on policies is financing the reserves that a library full of regulations requires insurers to keep. Thus there has been considerable incentive for life insurers to go more and more to the capital markets for funding. In the 1990s, many insurers went public. Now, many are acquiring debt financing to cover business expansion and maintainance of required reserves.
In this fashion, some life insurers have acquired exposure to the subprime mortgage credit debacle. ALL are affected by any impairment to the bond issuers. A variety of en vogue transactions, surplus note deals and policy block securitizations in particular, are particularly affected by any change in the credit markets, be it a downturn in market appetite for risk, steepness and volatility of the yield curve, and (this especially) rapidly widening credit spreads ( the risk premium investors command to pass over their money).
Keep in mind we are talking about the least correlated, least risky sector of the financial community and it is significantly affected by the subprime mess. Now, at the end of the day, life insurance policy values are determined mostly by the mortality of the insured population. The longer people live, the more valuable the cash flows are.
The exposure to subprime of life insurers has been on radar since August
NEW YORK, Aug 13 (Reuters) - Prudential Financial Inc. has the riskiest investment portfolio, including subprime exposure, among life insurers, while MetLife Inc. and Genworth Financial Inc. should be closely monitored, Citigroup analyst Colin Devine said in a report on Monday.
Devine said Prudential's (PRU.N: Quote, Profile, Research) portfolio had the greatest exposure to high-risk assets at 13.8 percent, with MetLife (MET.N: Quote, Profile, Research) close behind at 13.6 percent. Genworth (GNW.N: Quote, Profile, Research) followed with 9 percent, he said.
The average level of high-risk assets for life insurers as a percentage of total investments was 7.8 percent for 15 publicly traded life insurers, Devine said.
And via the troubles of the bond insurers, that risk exposure is coming home today. How much so? Let's see how the stock prices of some of the largest life insurers are doing:
Genworth is down 8.81% as of right now.
Oh, sidebar: Genworth's suprime exposure was not considered by Morningstar to be much of an issue
In the third quarter, Genworth recorded a loss of $17 million on its asset-backed securities backed by subprime and Alt-A mortgages. This write-down and the firm's $3.4 billion exposure to subprime and Alt-A loans does not concern us.
Lincoln National down 8.03%
AIG is down 5.85% as of this writing.
Get Met. It's down 4.01%
ING is down 3.84%
Prudential PLC (UK) down 3.43%
Prudential Financial down 3.40%
AXA down 3.29%
Sun Life down 3.07%
Manulife down 2.58%
Benchmarks: Dow down 2.47%, Nasdaq down 1.99% and S&P500 down 2.91% as of this writing.
Before you guys run off and think I'm smart
Seems the Germans figured this one out the day before
FRANKFURT, Jan 16 (Reuters) - The president of Germany's financial watchdog BaFin broke his silence on Wednesday, speaking for the first time publicly since the subprime crisis rattled Germany and warned that it could also suck in insurers.
"Insurers don't invest in a vacuum and so they have also been landed with structured products," said Jochen Sanio, president of the German Federal Financial Supervisory Authority (BaFin).
"Insurers could also be part of a bigger international group or financial conglomerate, which makes them vulnerable to what is happening; for example, when they are connected to a bank that manages a SIV (Structured Investment Vehicle) or Conduit."
"The issue is mainly reputational risk, but this should not be underestimated."