Municipal Bond Forum
On The Reality Behind the Bond Market Shakeup cont’d #4:
Q
I am a client of yours who has purchased several insured bonds. Could you explain whether and, if so, to what extent, these insurers will be negatively impacted by the collapse of the sub-prime market where, apparently, several of them provided insurance on junk paper? Will they remain capable of handling any muni defaults individually or as a group?
A
James A. Klotz responds:
We have consulted with Standard & Poor’s as well as ACA, one of the bond insurers often cited as having the greatest exposure to the sub-prime mortgage problem.
After analyzing the sub-prime mortgage exposure of all the bond insurers, S&P issued the following statement: “We believe the development of future losses will not be material in relation to the future earnings and capital positions of the companies.”
S&P’s opinion was arrived at after a lengthy analysis of all outstanding, rated mortgage- backed securities. S&P determined bond insurers had already established financial reserves for the most risky sub-prime securities in the event of default.
Since the bond insurers have mostly insured only the mid to higher levels of Collateralized Debt Obligations (CDOs) that contain sub-prime mortgages, a large segment of the CDOs would need to be in default before the insured layers would be impacted. This is not anticipated.
Despite a downgrade of 25% of the “BBB” rated sub-prime mortgage securities (and no others), S&P sees the impact on bond insurers to be small enough that it remains only a remote possibility that the insurers will see losses substantial enough to impact their ratings.
Naturally, defaults of sub-prime mortgage securities at levels beyond what seems likely could change that scenario. However, we have examined this situation independently and believe that S&P has done a diligent and thorough job in arriving at its conclusion.
As a result of this analysis, S&P has determined that the sub-prime mortgage situation currently poses no threat to the claims paying ability of the bond insurers.
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