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Fears over next victim of squeeze

Investor worries are mounting that the next big casualties from the credit squeeze might be the specialist companies that act as guarantors for bond issuers.

These companies, which write insurance to boost the credit ratings of various kinds of bonds, have seen their share prices pummelled and the cost of protecting their debt against default soar. Over the past week, sector leaders such as MBIA, Ambac, XL Capital Assurance, Radian and MGIC have all been hit hard.

In recent years, these companies, known as monolines, have moved away from their role of guaranteeing, or wrapping, bonds issued by US municipalities towards writing business related to structured asset-backed finance deals, such as mortgage-backed bonds and collateralised debt obligations.

Following the turmoil in structured credit markets, this business has turned sour, which could affect the cost of borrowing for the local US authorities who rely on their guarantees.

"Our conclusion is that MBIA and the rest of the financial guarantors are facing a prolonged period of stress," said Rob Haines, an analyst at CreditSights, a research house.

(...)

The cost of protecting $10m of MBIA's debt against default in the credit default swap market has soared from about $22,000 annually for a five-year contract back in February to more than $231,000 last week, said data provider CMA Datavision.

These monolines are rated AAA. That their default swaps jumped from 0.2% per annum to 2.3% per annum (multiplied by 10!) suggests that the market no longer believes that their ratings are worth anything.

The amounts covered by their guarantees are in the hundreds of billions of dollars - each.

These monolines have been serious competitors to banks in recent years as they could offer lower overall borrowing costs by, essentially, taking the risks, slicing them, repackaging them, and them reselling them in various tranches, the biggest one would get the AAA-rated gaurantee. This was cheaper thanks to the "dynamic" bond market and its appetite for the various underlying structured products. Oops.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Oct 30th, 2007 at 11:45:55 AM EST

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