Monday, February 25, 2008 0 comments ++[ CLICK TO COMMENT ]++

S&P February 25, 2008 Stress Test and Ratings Action

Well, I never thought that the monolines, who, even during their best days, are not even one-tenth the size of a decent bank, would have the power to rally the world markets as much as they did. The rallies in the last two days have been massive; but this also makes me concerned that there could be a big sell-off if positive news don't emerge. In any case, the cause of the rally today was favourable action towards MBIA and Ambac from the ratings agency S&P.

S&P carried out a new stress test and took the following ratings action (you can get their detailed report from their website):

  1. FGIC: Rating cut from AA to A; credit watch with developing implications
  2. XL: Rating cut from AAA to A-; credit watch negative
  3. CIFG: AAA affirmed (negative outlook)
  4. MBIA: AAA affirmed (negative outlook); removed from credit watch
  5. ABK: AAA affirmed; credit watch negative

(Assured Guaranty, FSA, Radian, and SCA were not reviewed for various reasons)

Nothing surprising in my eyes so there isn't much to say with respect to the actions. I should note that S&P's model has always seemed to post lower loss estimates for Ambac and MBIA than Fitch and Moody's. So I never really felt that it was a big hurdle to pass the S&P test. The real issue is with Fitch, who is very tough, and Moody's, who is supposedly the most respected rating agency. Recall that the whole present episode in the monoline theater was started with Moody's threatening to downgrade. I think it is more important to see what Fitch and Moody's say.

I haven't looked in detail to see what assumptions were changed in this stress test versus the prior ones. Compared to the December test, the monolines are taking much bigger losses.

(source: Detailed Results Of Subprime Stress Test Of Financial Guarantors, Standard & Poors, February 25, 2008)

Ambac is short by $400 million here, while MBIA is adequately capitalized, and FGIC is short by $2 billion. If Ambac raises close to $3 billion, that should be more than enough to satisfy S&P.

What should shareholders make of these stress tests? It's difficult to say. Clearly the rating agencies have a bigger credibility problem than the monolines. But one would assume that they will get a handle on the situation and start modelling things properly at some point. After all, they have some of the best, highly educated and well-paid analysts working for them. If the present rating agency modelling turns out to be correct, it's actually good news for shareholders. On the surface, it looks like there are huge losses that will occur. But remember that these are stress tests. Some of the assumptions likely won't materialize unless we get another Great Depression.

On another note, MBIA cut its dividend completely and is saying mark-to-market losses will likely be high in the first quarter. The weak first quarter is a dissapointment but the real question is actual losses. Ambac should also cut the dividend since it isn't helping anyone. Yes, you will lose some dividend-oriented index funds that blindly buys high yielding stocks but getting rid of the dividend may provide some ammunition against Bill Ackman and others who claim the holding company is draining reserves.

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