Sell Side

S&P Drops Ambac Three Notches to A

Ambac Financial Group Inc. last night announced that bond insurer subsidiary Ambac Assurance Corp. paid $1 billion to financial counterparties to commute four transactions representing $3.5 billion in collateralized debt obligation exposures. Earlier in the day, Standard & Poor's day downgraded the insurer three notches to A from AA.

Ambac expects to "record positive adjustments to its aggregate mark-to-market and impairment reserves" and that Ambac Assurance's rating agency capital position will improve as a result of the commutations.

The downgrade followed Moody's Investors Services downgrade on Nov. 6 of Ambac to Baa1 from Aa3, which came just hours after the bond insurer's parent, Ambac Financial Group Inc., reported a $2.431 billion third-quarter net loss. The outlook on Ambac's rating remains negative.

"The rating action on Ambac reflects our view that the company's exposures in the U.S. residential mortgage sector and particularly the related collateralized-debt obligation structures have been a source of significant and comparatively greater-than-competitor losses and will continue to expose the company to the potential for further adverse loss development," Standard & Poor's credit analyst Dick Smith said in a statement. "These losses have slightly more than offset the benefits to the company of lower capital requirements that result from a declining book of business."

Standard & Poor's also said yesterday it did not expect to take action on MBIA Insurance Corp.'s AA rating following MBIA Inc.'s $806.5 million third-quarter net loss and its increased reserves relating to its second-lien mortgage exposure.

MBIA's reserves taken and claims paid are less than the losses generated in Standard & Poor's stress testing and its impairments on CDOs are "meaningfully less" than Standard & Poor's loss assumptions, the rating agency said. In addition, the liquidity at MBIA Insurance and the asset liability management business "appears relatively strong."

Moody's earlier action already caused the biggest immediate ramification of a downgrade to Ambac - triggering termination payments and collateral postings in Ambac's financial services businesses' portfolios. Ambac said following Moody's downgrade that it likely faced a $3.2 billion shortfall in its guaranteed investment contracts and derivative portfolios.

Ambac then received approval from the Wisconsin insurance commissioner's office to use resources at Ambac Assurance to help plug that gap. Ambac Assurance can buy up to $3 billion of securities from the investment agreement business and can provide unsecured revolving credit facilities of $1.6 billion to the investment agreements business and $750 million to Ambac Financial Services, according to a quarterly report it filed with the Securities and Exchange Commission earlier this month.

The support has "lowered slightly the credit quality of Ambac's investment portfolio and increased the gap between the book value and fair-market value of the assets in the portfolio," Standard & Poor's said. But Ambac still "exhibits sound claims-paying ability at it s current rating and adequate liquidity levels," the agency added.

Standard & Poor's also downgraded the senior unsecured debt of Ambac Financial Group to BBB from A, and the hybrid security debt to BB-plus from BBB-plus. The downgrade reflects previously identified loss development, capital adequacy and liquidity assessments, and the "added stress" at the holding-company level from Ambac Assurance's inability to pay dividends in 2009 without regulatory approval.

Stock of Ambac Financial Group fell 33.33% to $0.76 yesterday. The close marked the first time since Ambac went public in 1991 that its stock had fallen below $1. As recently as May 18, 2007, Ambac stock hit an all-time high of $96.08 per share.

The downgrade is unlikely to have much of an impact in the municipal market. Market participants largely expected the downgrades, even if initially the size of the Moody's downgrade may have been a bit of a surprise.

"Realistically, it's just an acknowledgement of the fact the companies are having trouble, and everyone knows that," said Guy LeBas, fixed-income strategist at Janney Montgomery Scott. "They've already been downgraded severely by Moody's, so I think the impact is marginal at best."


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