Losses on Subprime Seconds Mount, Pressure Bond Insurers

An earlier warning this week from Moody’s Investors Service over worsening performance of subprime second liens and associated implications for the Aaa ratings of key monoline bond insurers led both MBIA Inc. (MBI) and Ambac Financial (ABK) to publicly contest the agency’s suggestion that their ratings were at risk. Moody’s said that it now expects subprime second lien pools to lose 17 percent in the 2005 vintage, on average; losses are expected to average 42 percent in the 2006 vintage, and 45 percent in the 2007 vintage, the agency said. The higher losses might “materially impact” the capital adequacy needed by bond guarantors to hold on to their Aaa credit ratings, Moody’s suggested. In a press missive fired off Wednesday afternoon, Ambac said it has “no material exposure to subprime borrowers” in either of its HEL or HELOC portfolios, although it does hold $4.6 billion in non-subprime closed-end seconds and another $8.8 billion in exposure to non-subprime HELOCs. “We have already taken substantial reserves against our CES and HELOC portfolios,” the company said in a press statement on Wednesday. “Moreover, we have not assumed any recoveries related to our active remediation efforts … we believe we have already exceeded Moody’s stressed Aaa target as of April 30th, 2008 and we continue to build excess capital.” MBIA also argued that it has less exposure to the troubled asset class singled out by Moody’s than the agency suggested, saying that there are “significant differences between subprime second lien pools referenced in Moody’s report and the prime second lien securitizations we have guaranteed.” The company didn’t clarify what those difference were, but did say that it has been aggressively putting second liens back to originators on the basis of misrepresenting the borrower’s credit as prime. “We continue to believe that our direct Residential Mortgage Backed Securities expected losses are modestly above Moody’s expected losses,” the company said, “and significantly less than their stress loss estimates based on their transaction level review in February of 2008.” New losses unveiled Wednesday at Financial Security Assurance Holdings Ltd., a unit of the Belgian bank Dexia SA, underscored that second liens may yet prove problematic for bond insurers, regardless of whether in prime or subprime credit classes. FSA increased its loss estimate by $355 million as losses rose in its $4.5 billion HELOC portfolio during the quarter, according to a report published Thursday by the Wall Street Journal. The jump in reserves led the insurer $421.6 million into the red for the quarter. FSA, along with Assured Guaranty Ltd., is one of only two bond insurers that has kept a stable AAA credit rating from all three major rating agencies.