Sell Side

Rating Agencies Add To Insurers' Woes

Moody’s Investors Service announced late yesterday it was placing MBIA Insurance Corp., and any of the bonds currently insured by the financial guarantor, on review for possible downgrade.

“Today’s rating action reflects Moody’s growing concern about the potential volatility in ultimate performance of mortgage and mortgage-related collateralized debt obligation risks, and the corresponding implications for MBIA’s risk-adjusted capital adequacy,” Moody’s said in a release.

The announcement comes a day after Moody’s placed Ambac Assurance Corp. on review for downgrade, after the bond insurer announced $5.4 billion in pre-tax mark-to-market losses in its derivative portfolio for the fourth quarter of 2007. Ambac also released a capital raising plan that may be similar to that put forth by MBIA in recent weeks.

In response to the announcement, Ambac said management was confident in the company’s insured portfolio and that it was ”assessing the impact” of the Moody’s action on the previously announced capital plan. Management will comment further in a conference call set for Jan. 22.

In yesterday’s announcement about MBIA, Moody’s went on to say, as they did with Ambac, that the review will also consider the potential for bond insurance going forward. As the bond insurers suffer ever-increasing mark-to-market losses on the derivatives they insure, many market participants believe that the usefulness for bond insurance in the municipal market will be eroded.

Concluding their own recent review, Standard & Poor’s also announced yesterday the findings of a review of the bond insurance stress tests the company first conducted in December. Standard & Poor’s said it did not expect the increased losses to significantly impair the capital positions for those bond insurers the rating agency currently has on negative outlook or credit watch. The projected residential mortgage-backed security related losses at each financial guarantor ranged from an increase as low as 2% to a high of 36%.

The bond insurers suffered further losses yesterday as equity investors sent the stock prices plummeting for the five publicly listed companies, calling into question the viability of the recently announced capital plans and the triple-A ratings they were meant to bolster.

In New York Stock Exchange trading, Ambac shares plunged 52%, or $6.73, to $6.24, as nearly 63 million shares changed hands. Likewise, MBIA Inc. shares plunged 31%, or $4.18, to $9.22, as more than 33 million shares changed hands.

The mounting losses on residential mortgage-backed securities that the bond insurers wrap, as well as the plunging market capitalization caused by a fall in stock prices, has caused further uncertainty in the bond insurance industry.

The loss in market capitalization brings into question the success of the recent capital plans announced by Ambac and MBIA. While MBIA’s capital plan appears successful, and led to a reaffirmation of its triple-A rating with a stable outlook by Fitch Ratings, questions remain about whether it will be enough to cover future losses in its derivative portfolio.

Ambac, however, has yet to unveil the details of its capital plan. The company said it would likely raise the needed capital through a sale of equity or equity-linked securities, while analysts said it is likely to be a convertible share or some other from.

“More than likely it would come out of a hybrid-type offering, which would be more of a convertible or some type of debt relationship,” said Morningstar equity analyst Jim Ryan.

Ambac could also follow in the footsteps of MBIA Insurance Corp., which sold $1 billion of surplus notes last week.

However, the recent performance of those notes may preclude Ambac from pursuing their own sale. Since selling last week, the notes have traded at times at around 85 cents to the dollar, leading to yields as high as 18%. The notes originally sold with an interest rate of 14% for the first five years.

“Not only have volatility and rating concerns likely precluded a similar issuance by Ambac, the levels that it would need to price a deal at are now prohibitively extensive,” wrote Rob Haines, senior analyst at CreditSights, in a recent report.

Yesterday’s fall in stock price may also make Ambac vulnerable to either a takeover or a large influx of preferred capital, which would dilute existing shares and send shareholders running.

“They become targets for large equity infusions, which will certainly dilute existing shareholders,” Ryan said.

For that to happen, investors must see the bond insurer as a worthy investment. Spreads on the debt held by the bond insurer widened yesterday, to the point where investors now view the company’s debt as distressed.

According to Phoenix Partners Group, an inter-dealer broker, the cost of protecting Ambac’s debt against default rose to as high as 29% in a lump sum up front today, compared to 16% yesterday. Credit protection trades on an up-front basis when investors consider a company distressed, according to Phoenix. MBIA fared worse, as the cost of protecting MBIA’s debt from default rose to a high of 30% today, after being at 16% yesterday.

“Given the dramatic decline in Ambac’s stock price and the deterioration of its bond spreads, Ambac’s ability to raise sufficient capital to avoid a downgrade is now in significant doubt,” Haines wrote.


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