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Moody's Drops Ambac Insurer Rating

Moody's Investors Service Wednesday afternoon downgraded the insurer financial strength rating of Ambac Assurance Corp. to Baa1 with a developing outlook from Aa3 on review for downgrade. The change came after the bond insurer's parent, Ambac Financial Group Inc., earlier in the day reported a net loss of $2.431 billion for the third quarter.

Moody's cited expectations of greater mortgage-related losses, the possibility of even greater than expected losses in extreme stress scenarios, Ambac's diminished business prospects, and its impaired financial flexibility for the downgrade. On Sept. 18, Moody's placed Ambac Assurance's Aa3 rating and MBIA Insurance Corp.'s A2 rating on review for downgrade.

Ambac Financial Group has said a downgrade would trigger collateral postings and terminations in its guaranteed investment contracts and global derivatives portfolio that would create a shortfall of $3.2 billion.. The company said during an earnings conference call earlier in the day that it is in discussions with Wisconsin insurance regulators to develop a solution for the shortfall, such as moving money from Ambac Assurance to the financial services unit.

"Today's rating action concludes a review for possible downgrade that was initiated on Sept. 18, 2008, and reflects Moody's view of Ambac's diminished business and financial profile resulting from its exposure to losses from U.S. mortgage risks and disruption in the financial guaranty business more broadly," Moody's said in a statement.

Moody's dropped Ambac Financial Group to Ba1 from A3, leaving it at junk status. Moody's said Ambac Assurance's developing outlook represents the possibility of further deterioration of Ambac's insured portfolio, any commutations or terminations of structured finance exposures that could occur, any successful remediation efforts and the impact of plans the federal government could take to stem the rising number of mortgage defaults.

The news came at the end of the day in which both Ambac and MBIA reported large third-quarter losses as a result of continued credit market turmoil and housing market deterioration.

Ambac posted a net loss of $2.431 billion, or $8.45 per share, citing among other reasons net mark-to-market losses on credit derivatives and increased loss provisions, primarily on second-lien residential mortgage-backed transactions. MBIA recorded a net loss of $806.5 million, or $3.48 per share, citing second-lien residential mortgage-backed exposures and net losses at its asset liability management business.

"In the U.S., specifically and far from alone in this, house prices have declined significantly, consumer confidence has hit record lows, and credit markets have suffered, more or less, complete seizure," Ambac chief executive officer and president David Wallis said in a conference call. "Unsurprisingly, official and consensus views on the economic outlook have deteriorated. That is the story of the last three months, and this quarter's results are reflective of this distress in context."

An increase in projected losses on Ambac's portfolio of high-grade collateralized debt was the main driver in the company taking an impairment loss of approximately $2.509 billion on its credit derivative portfolio, which had a total mark-to-market loss of $2.705 billion for the quarter. Ambac also had a net loss provision of $607.7 million, mostly related to second-lien RMBS transactions.

One quarter after making no adjustments to its projected losses on mortgage-related exposures, MBIA increased its case loss reserves $961 million for its second-lien RMBS exposures.

Ambac reported a net operating loss of $7.81 per share, while MBIA posted a net operating loss of $2.22 per share. The stocks both plunged, with Ambac falling 40.08% to $2.01 and MBIA dropping 21.99% to $8.16.

As their losses continue to mount, the insurers have sought to take part in the Treasury Department's $700 billion Troubled Assets Relief Program. Ambac and other insurers have made working on TARP a "focus" for the near term, Wallis said.

So far, the Treasury has made no specific plans for aiding insurers, although a number of recommendations have been made. Ambac, for instance, has suggested the government's guarantee program could be used to back a portion of the insurers' excess losses - freeing up capital - or to directly back existing securities - lowering the capital risk of future downgrades for the securities and increasing liquidity for them. Regulators in New York and Wisconsin have separately said the Treasury could inject capital into the insurers through the capital purchase program.

Any TARP benefits for insurers could have wide-reaching implications, executives and regulators have said. It could help municipal issuers, banks that have written down exposure to monolines, student loan organizations, and others, Wallis said.

A number of insurers replied to the Treasury's request for proposal on the guarantee program with their own thoughts on how it should be run. There has been dialogue, but no formal response from Treasury, Wallis said.

"Clearly it is not in the interest of taxpayers ... to prop up a failing institution; that isn't we believe where we sit," Wallis said. "We think our issues are liquidity, along the lines we've discussed, not solvency."

Both Ambac and MBIA also said early yesterday they plan to push ahead with plans for launching their own municipal-only insurers. Ambac said it is in discussions with rating agencies about Everspan Financial Guaranty Corp. - formerly Connie Lee Insurance Co. - after delaying its planned $850 million recapitalization plan when Moody's Investors Service in September said it would review for downgrade the Aa3 rating of bond insurer Ambac Assurance Corp.

Some have said some additional insurance capacity in the municipal market could have thawed some of the recent freeze-up, and that insurance penetration could rise to as high as 35% of the market with the right number of triple-A insurers. Others believe issuers and investors will be reluctant to trust any new insurer, especially one linked to the legacy monolines.

The insurers are confident there is demand for their product and that they can sufficiently wall off any new insurer from problems of the older guarantors.

"For every person you can find that says there is no need for insurance, you're going to find an equal number, particularly in the retail sector a large number, of people who believe insurance, if it could come from a clean company reconstituted, will, in fact, be an effective way to continue to help effect sales in that area," said MBIA chief executive officer Jay Brown of the municipal market.

With Ambac now downgraded, a potential downgrade still hangs over MBIA, whose A2 rating Moody's in September put on review for downgrade. MBIA says it has the cash and liquid assets available to meet any terminations in its guaranteed investment contracts portfolio that would be triggered by a downgrade. In addition to a rebalancing it undertook, MBIA has used $600 million in cash to "enhance the liquidity position" of the asset liability management portfolio and also received regulatory approval to transfer as much as $2 billion in assets from that portfolio to bond insurer MBIA Insurance Corp. in return for cash.

Both companies have also looked to recover some of the claims they have paid out on their structured finance exposures by finding substantiated breaches of representations and warranties. MBIA has already sued Countrywide Financial Corp. and Residential Funding Co. and filed a claim against IndyMac Bank. Ambac yesterday sued EMC Mortgage Corp. in federal district court in the Southern District of New York.

During the third quarter, Ambac added an additional $250 million of expected recoveries, bringing its total to $512 million. MBIA has not yet included any expected recoveries in its loss estimates.

Meanwhile, Radian Group Inc. reported a third-quarter net income of $36.7 million, or $0.46 per share, compared to a $703.9 million, or $8.82 per share, net loss from the third quarter last year. It noted it completed the transfer of bond insurer Radian Asset Assurance Inc. to mortgage insurer Radian Guaranty Inc. during the third quarter.

Radian Asset has $2.9 billion in claims-paying resources and a $935 million surplus, along with little exposure to the housing markets. It has stopped writing new business for the "foreseeable future" and will serve to contribute capital to the mortgage insurer.

"Financial guaranty now serves as an important source of non-dilutive capital for our mortgage insurance business and we have rearranged our financial guaranty operations commensurate with this new purpose," said Radian Group chief executive officer S.A. Ibrahim.


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