Banks Face Ratings Cuts as Bond Insurers Falter

I don’t typically cover too much of the backside of the mortgage market – particularly the bond insurers and the pivotal role they play in the secondary market function. But like the rest of the gang they’ve been getting their lunch handed to them by the poor performance of mortgages that make up the debt obligations that they guarantee.

In fact, the carnage is so bad that many of the biggest banks in the world could face downgrades as a result of these bond insurers faltering in the face of the onslaught of delinquencies, foreclosures and other non-performance issues.

From Market Watch on how banks may be downgraded as a result of the flailing bond insurers:

“Bond insurers are suffering as a result of their roles as guarantors of mortgage-related securities, and downgrading them could affect all markets in which they are active, including the municipal bond, commercial mortgage-backed securities, and other structured finance areas,” Tanya Azarchs, a credit analyst for S&P, wrote in a note to investors. “In turn, dislocation in those markets could affect banks.”

Bond insurers guarantee billons of dollars worth of complex securities known as collateralized debt obligations (CDOs). But losses on these securities have begun to rise, imperiling the companies’ crucial AAA ratings. Banks and securities firms lost close to $146 billion from subprime-related products in 2007.

S&P estimated that bond insurers have guaranteed at least $125 billion of the principle and interest payments of subprime-related CDOs.

“We believe that the specific, identifiable effect on banks may be significant and, in a few cases, could lead to downgrades. Large global institutions have direct exposure to the bond insurers in a number of ways,” Azarchs said

Besides the doom and gloom of these insurers falling apart there was another interesting note in the article that only received one line of attention but speaks to the continuing larger problem that the mortgage market is facing.

The formerly hot CDO market has since slowed down to a trickle, with only one created in the U.S. in 2008.

Collateralized debt obligations were a massive conduit for mortgage liquidity as mortgage backed securities were packed in to CDOs and sold off to investors hungry for yield. For all the folks out there who continue to parrot that “the secondary market is coming back” simply refer them to the above sentence. While not the be all, end all in terms of providing mortgage liquidity, CDOs were a critical part in the liquidity expansion for the market and without them or a similar conduit the secondary market will continue to be severely impaired.

One CDO in all of 2008 is insane – that’s a truly dead market.