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Risky Paper Hammers MBIA

The bond insurer is in a freefall after it detailed its exposure to risky structured products.

Updated from 12:49 p.m. EST

Bond insurer



shares plunged anew Thursday, after its bombshell revelation of its significant exposure to the riskiest asset-backed paper.

The financial guarantor's shares dove more than 30% in early trading after the firm announced that it guarantees $8.1 billion of structured products called CDOs-squared, among some $30.6 billion in total exposure to CDOs, or collateralized debt obligations. That means MBIA guarantees payment on CDOs that package up other CDOs. Many are filled with subprime or other mortgage-backed debt, which has been subject to downgrades, deterioration in value and default of late.

The revelation sparked a warning from Fitch Ratings, a day after a similar action by Standard & Poor's, which could ultimately force the firm to scramble for yet more capital. MBIA received a $1 billion cash injection from private equity firm Warburg Pincus last week.

"We are shocked that management withheld this information for as long as it did," writes Ken Zerbe, analyst at Morgan Stanley in a note Wednesday.

A call to MBIA was not returned.

The news comes as investors are increasingly concerned that the credit market woes that have roiled financial markets in the second half of this year will intensify with the potential default or credit rating slide for a financial guarantor.

MBIA Collapse Could Snowball Across Street

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The credit ratings agencies have been scrutinizing the finances of companies like MBIA and competitors




Financial Guaranty Insurance Co.


XL Capital Assurance


CIFG Guaranty


Financial Security Assurance

. The guarantors rely on having pristine credit ratings and more than enough capital to guarantee that investors receive their payments on securities they own.

A ratings downgrade could force some fixed-income investors into a selling spree, because parameters of their investment funds require that their holdings be insured by a guarantor with a triple-A rating.

Thursday afternoon, Fitch Ratings responded to MBIA's news by putting the company's credit ratings on "watch for a possible downgrade." The agency notes that MBIA comes up short of a triple-A credit rating by about $1 billion of capital due to CDO downgrades, and that's including the recent $1 billion investment in MBIA by private equity firm Warburg Pincus.

Fitch essentially gives the firm four to six weeks to "obtain further capital commitments and/or put in place reinsurance or other risk mitigation measures." Fitch says it expects to downgrade the firm to double-A-plus if it cannot come up with the capital in time.

According to a


report, MBIA insures the most bonds, guaranteeing $673 billion. Ambac is second, insuring $556 billion.

But the fallout of a guarantor downgrade reaches beyond forced bond sales. The guarantors also underwrite credit-default swap protection on securities like bonds, CDOs and other asset-backed debt. These firms have already taken writedowns based on widening risk premiums, or credit spreads, on their credit default swap portfolios, and analysts expect they'll take more. Credit default swaps are derivative products banks and credit investors buy to hedge against default risk in the underlying securities.

Zerbe had thought Ambac had more risky CDO exposure until MBIA's announcement Thursday. He notes that the news validates S&P's prediction that MBIA's stress-case scenario would engender losses 61% higher than Ambac's $1.5 billion.

Likewise, other financial institutions have exposure to the guarantors. Private equity firm



has suffered from its investment in FGIC, according to a

Wall Street Journal

report. And many banks and brokerage firms are buyers of guarantors' insurance and credit default swaps as well, begging the question -- why wouldn't someone pony up cash to rescue the firms from capital shortfalls?

According to a

New York Times

report Wednesday,

Merrill Lynch



Bear Stearns


were negotiating a bailout of smaller insurer

ACA Financial Guaranty Corp.

, but they were too late. The firm's rating was slashed Wednesday deep into junk territory by Standard & Poor's, to triple-C from single-A. Last month, controlling shareholders of its French parent company invested $1.5 billion for CIFG Services in November. And, just last week, MBIA obtained a $1 billion investment from Warburg Pincus to protect its investment-grade rating.

MBIA's exposure announcement comes on the heels of several ratings agencies' reviews of guarantors' capital adequacy levels as the credit crunch wears away at their ratings. In addition to cutting ACA's rating Wednesday, S&P affirmed MBIA's key triple-A rating, but revised the company's outlook to negative from stable. S&P's ratings action followed on the heels of others' similar reviews. Moody's Investors Service last Friday also affirmed MBIA's credit rating as triple-A, but also revised its outlook to negative from stable.

The agencies were less than sanguine about the outlook for these firms, and emphasized the importance of raising capital to defend their ratings. Of affected companies, S&P writes Wednesday, "their capital resources may no longer be sufficient at their respective rating levels."

"We will be focusing on both the effectiveness of the companies' capital remediation plans and their risk management strategies going forward," writes Moody's in its release Friday.

Shares of MBIA recently were down 26.4% to $19.90, while shares of Ambac had slipped 2.4% to $26.80.

Following S&P's ratings action Wednesday, MBIA's CEO Gary Dunton said he was "pleased S&P affirmed the company's triple-A ratings as we continue to make progress towards the implementation of a capital management plan during the first quarter of 2008," according to a press release. "We are confident that we will successfully manage through this challenging period, while growing the business profitably, and return to Stable Outlook."

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


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