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S&P Takes Action on Five Bond Insurers

Standard & Poor's yesterday released rating actions on five of the bond insurers, downgrading two and maintaining AAA ratings on the others, although with indications that they will continue to monitor the insurers' capital positions and subprime exposure closely.

The rating agency lowered Financial Guaranty Insurance Co. to A from AA, maintaining a credit watch with developing implications, while downgrading XL Capital Assurance Inc. to A-minus from AAA and keeping it on negative watch.

The agency affirmed the AAA rating for MBIA Insurance Corp. but took it off credit watch and gave it a negative outlook. Ambac Assurance Corp. remained at AAA, and on credit watch with negative implications. CIFG Guaranty also saw its AAA rating affirmed and its negative outlook maintained.

Late yesterday, in a letter to shareholders, Joseph "Jay" Brown, chief executive officer of MBIA Inc., the parent of the financial guarantor, for the first time specified his plans for the insurer's future.

"As soon as it's feasible but within a five-year period, we will restructure the company in such a way as to insure public and structured finance business from separate operating entities," Brown said.

The rating actions follow from the latest stress tests conducted by Standard & Poor's, in which they looked at the exposure of the financial guarantors to non-prime U.S. mortgages. The loss estimates were the same as those released on Jan. 17, with the exception of the 2006 and 2007 vintage alt-A mortgages, which increased to 5.5%, from 3.5%, and to 9%, from 3.5%, respectively.

Standard & Poor's also increased the loss assumptions for collateralized debt obligations.

In the report, Standard & Poor's said the loss assumptions will be "no less than, and perhaps higher than, the ultimate loss levels experienced." The assumptions calculated by the bond insurance team were higher than those of its structured finance divisions, in an effort to pose a high stress level to each company.

"Certainly there has been a lot of discussion that these loss assumptions have been shifting over time, and part of that relates to the fact that there has been mortgage market deterioration," said Standard & Poor's managing director Howard Mischel. "What we are trying to do is get out ahead and try to figure out how far this is going to move and try to set up goal posts that were fixed to the ground."

In moving MBIA back to a negative outlook, Standard & Poor's cited the bond insurer's recent success in raising $2.6 billion and the support of the company's franchise that the capital raising indicated. The rating agency also cited possible reinsurance transactions as contributing to the company's upgrade from negative watch.

"Clearly from MBIA's case stepping back from a credit watch is like stepping back away from the edge of a cliff," Mischel said. "That's an important development, I think."

Yesterday, MBIA Inc. announced that it would eliminate the quarterly dividend paid to stockholders. The move would save the company an additional $174 million, MBIA said in a release.

In its earlier release, Standard & Poor's kept the company on negative outlook because of questions regarding the company's corporate structure, franchise value, and the possibility of "disadvantaging" a group of policy holders, namely the investment banks that bought credit protection on the structured products..

Fitch Ratings released a report yesterday that looked at these policy holders, the counterparties in insurance policies on the structured finance side of the business, and found that in most cases, losses related to these transactions will not result in ratings downgrades.

"In the event of moderate guarantor downgrades, losses taken by financial institutions should be well contained," Fitch said in the release. "However, any substantial downgrades [to the financial guarantors], particularly to below investment grade, would result in significant losses, not to mention potentially costly knock on effects."

Of the banks that Fitch looked at, Citigroup Inc. - reported to be a member of the group looking for a solution for Ambac - has a notional exposure on total hedges related to "super senior" asset-backed security CDOs insured by Ambac of $5.5 billion, and an additional $1.4 billion in notional value to subprime trading assets tied to Ambac.

This group may be left out in the case where MBIA, or any of the other bond insurers, elects to split itself into two distinct units. Such a scenario would separate the municipal bond insurer from a structured finance insurer.

FGIC has already announced its intention to split itself in a similar manner, and reports say Ambac may also consider such a move.

Last Tuesday, Ambac spokeswoman Vandana Sharma said that Ambac was evaluating its various lines of business to determine the company's strategy going forward. She also declined to confirm any of the recent reports related to an Ambac bailout plan that could be imminent.

On Friday and over the weekend, reports surfaced that Ambac's parent, Ambac Financial Group, may be close to finalizing a deal with a group of eight banks to raise $3 billion in capital and potentially save the bond insurer's triple-A rating.

Standard & Poor's said Ambac's unchanged rating was a reflection of the insurer's capital raising plans and the company's ability to implement those plans. The rating action quoted other reports that Ambac could raise "at least" $2 billion in capital, which Standard & Poor's said would more than adequately cover the company's $400 million shortfall.

A number of news outlets, quoting anonymous sources, said an announcement could come as early as yesterday or today, while other sources told The Bond Buyer that an announcement is likely to come early next week.

According to sources quoted by the Wall Street Journal and others, the deal is likely to include $2.5 billion in equity sold through a rights issue, which would offer the stock to existing shareholders at a discount to the current market price. Under the plan, the group of eight banks - including Citigroup, UBS, Wachovia Corp., Barclays PLC, Royal Bank of Scotland Group PLC, Societe Generale, BNP Paribas, and Dresdner Bank AG - would likely backstop the deal, agreeing to buy any unsold shares.

Under the plan, Ambac would also sell $500 million of debt, the newspaper said. The debt would likely be surplus notes similar to those sold by MBIA Inc. last month, and will be expensive for Ambac. MBIA's surplus notes were sold with a 14% yield, which rose even higher after the sale as the notes traded lower in secondary market trading.

Yesterday, CNBC reported that a deal was finalized and being brought to the rating agencies for their final approval.

Mischel, while declining to confirm or deny whether he had seen such a proposal from Ambac, did say that Standard & Poor's will evaluate it when they see it and make the appropriate comments.

"I think it's appropriate to wait until they are ready to move forward with whatever proposal they are ready to put out," Mischel said. "Then we'll be asked to look at that in its final form and be able to respond as a rating agency."

Ambac executives told the Wall Street Journal that they may elect to shunt some of the muni business to a small insurer Ambac bought a decade ago, the College Construction Loan Insurance Association. This insurer is already rated triple-A and licensed in 47 states.

Standard & Poor's left Ambac on negative watch because of the uncertainty surrounding the latest plans.

"We left the ratings on CreditWatch with negative implications to reflect uncertainty surrounding the risk profile and capitalization plans for the reported new corporate structure being contemplated by the holding company," Standard & Poor's said in the release.

The stock price of the public financial guarantors rebounded on the Standard & Poor's rating news. MBIA's stock price rose 20% yesterday, or $2.40, to $14.58 in New York Stock Exchange trading, while Ambac's stock price rose 16%, or $1.70, to $12.41, and Security Capital Assurance, the parent of XL Capital, rose 16%, or $0.25, to $1.80 in NYSE trading.

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