Ambac Financial Group Inc. Wednesday night received approval from Wisconsin regulators to use resources at bond insurer Ambac Assurance Corp. to provide support to its financial services unit, which faces a shortfall of $3.2 billion as a result of a recent downgrade to the financial guarantor.
Moody's Investors Services Tuesday downgraded Ambac Assurance Corp. to Baa1 with a developing outlook from Aa3 on review for downgrade, triggering terminations of contracts and the need for collateral postings in the financial services portfolio.
"We continue to work collaboratively with the [Wisconsin Office of the Commissioner of Insurance] as we seek to reduce balance sheet risk in an orderly fashion," Ambac chief financial officer Sean Leonard said in a statement. "This increased financial flexibility will enable us to maximize the value of financial services assets for the benefit of all of our stakeholders."
In September, Wisconsin regulators gave permission for Ambac Assurance to provide up to $1 billion in support to the financial products unit through asset purchases and secured loans. Ambac Assurance guarantees almost all the transactions in the portfolio.
"I feel comfortable that we can give them the liquidity as we look at things today from the insurance company," Wisconsin insurance commissioner Sean Dilweg said in an interview yesterday.
Moody's Wednesday afternoon downgraded Ambac, hours after Ambac Financial posted a $2.431 billion loss for the third quarter. That included an approximately $2.509 billion impairment it took on its credit derivative portfolio, mostly stemming from an increase in projected losses on Ambac's portfolio of high-grade collateralized debt.
Moody's cited greater expectations of losses on mortgage-related exposures, the possibility of even greater than expected losses in extreme stress scenarios, diminished business prospects, and impaired financial flexibility for the downgrade. Moody's expectations are "broadly consistent" with Ambac's reported losses and increases in loss reserves, the rating agency said.
Ambac said "that the timing and extent of this rating action is unfortunate," noting its commutation and remediation efforts, while saying the potential benefits from the Treasury Department's $700 billion Troubled Asset Relief Program are still unknown.
"It appears that this rating action has been precipitated by our earnings announcement," Ambac president and chief executive officer David Wallis said in a statement. "It is disappointing that Moody's has come to a ratings conclusion without the benefit of completing its own analysis of our portfolio."
Ambac Assurance will not be able to pay dividends to the holding company in 2009 without regulatory approval, executives said in a conference call yesterday. Even with regulatory approval for the assistance from Ambac Assurance to meet the shortfall, "the capital would serve simply to delay an eventual default" at the holding company, JPMorgan analysts yesterday wrote.
In addition, many analysts remain skeptical about how much the Treasury can help Ambac and other bond insurers, especially with an increasing number of industries looking for federal aid. Ambac has said the industry could benefit from the TARP guarantee program, and regulators have suggested the Treasury could take an equity stake in the companies.
"Any systemic effects that would come as a result of problems at Ambac have already hit," said Guy LeBas, fixed-income strategist at Janney Montgomery Scott LLC. "So I don't think the Treasury has a big mandate to try to support them. Not to say it couldn't happen, but it's hard to come up with a line of reasoning why it should."
Bond insurance executives and regulators have suggested TARP support to financial guarantors could help several sectors, including the municipal market.
Ambac stock dropped 24% yesterday to $1.52. It had plunged 40.08% to $2.01 on Wednesday with Moody's announcement coming after the market closed.
The market largely expected downgrades to Ambac, participants said. Like bonds wrapped by most insurers, Ambac-backed bonds basically trade through to their underlying levels. And leveraged holders "most vulnerable" to a ratings downgrade no longer have large holdings of municipal bonds, Matt Fabian, managing director at Municipal Market Advisors said.
"In theory, it shouldn't have much of an impact," Fabian said.
Still, Fabian noted that Ambac itself had believed the situation was stabilizing and it's unclear "to what extent people have invested in that optimism." Even if the market expected a downgrade, a four-notch move is still a "major event," said Dick Larkin, senior vice president, and director of research at Herbert J. Sims & Co.
And in the current stressed environment, it could still have an impact, said Joe Darcy, senior portfolio manager at Dreyfus Corp.
"The liquidity characteristics that underlie the muni market in general at this point are so strained that anything that carries any kind of negative connotation associated with a specific bond impairs its liquidity if just one person out there says 'You know what, I got a choice between buying something that has a ding and one that doesn't have a ding. Give me the one without the ding,'" Darcy said. "And so one person less as a liquidity provider to a specific issue that appears to be quote-unquote tainted is going to impact the value."