Ambac Assurance Hopes to Keep Triple-A

After reporting a $1.66 billion loss for the first quarter, Ambac Financial Group Inc. is once again in a position of having to defend itself to a market and investors asking a single question: Will Ambac Assurance Corp. be able to keep its two triple-A ratings without raising more capital?

The company certainly thinks so. In a conference call last Wednesday to discuss the first-quarter earnings, Ambac executives said despite first-quarter losses, the monoline's capital remains in excess of the triple-A threshold for both Standard & Poor's and Moody's Investors Service.

Both agencies assign a triple-A rating with a negative outlook, while Fitch Ratings assigns a AA rating with a negative outlook.

Ambac has a capital cushion of about $700 million above Standard & Poor's threshold and exceeds Moody's minimum triple-A level but falls short of the "target" line by about $300 million, chief executive officer Michael Callen said in the call. By the end of the year, he expects to exceed the "target" levels for both agencies' models.

"Provided we are judicious with our underwriting, I would anticipate we would be well in excess of $1 billion with S&P and have a $500 million to $600 million surplus by the end of the year for Moody's," Callen said.

In the first quarter, the company freed up about $390 million by not writing new business and running off expired policies and Callen said he expects to free up an additional $400 million in the second quarter. As more capital-intensive exposures run off, more capital will be freed up, said Ambac spokeswoman Vandana Sharma.

"Generating capital in this way is the most efficient way to do it," she said.

However, Callen's analysis may be irrelevant if further deterioration in the U.S. housing market leads the rating agencies to change their capital adequacy requirements and alter the triple-A capital thresholds. It is difficult to predict how bad insurers' mortgage-related losses would be, Moody's said, a point further accentuated when Ambac reported worse-than-expected losses for the first quarter larger-than-expected loss.

"Absent a complete stabilizing of the mortgage and related securities markets, it is likely that Ambac may have to consider raising additional capital," wrote CreditSights analyst Rob Haines in a recent report.

In the current environment, Ambac appears to have a small cushion. Total credit impairment for the company's mortgage-related securities was about $3.3 billion in the quarter, according to the rating agency. This was higher than the rating agency's expectations by about $900 million, but below the worst case scenario by about $2.1 billion.

If other aspects of Ambac's portfolio are held constant - assuming non-mortgage losses are contained - Ambac would need to have mortgage-related losses higher than $2.1 billion to need additional capital.

"Moody's will continue to evaluate Ambac's mortgage-related exposures in the context of actual performance as well as its developing view of the depth of the housing market's decline," the rating agency said in a report last week reiterating its negative outlook on Ambac .

If the mortgage market declines further, current rating agency views would change.

Analysts believe the losses could continue to mount. While the mortgage market has started to improve, the risk remains for the monolines as defaults continue to rise, said T.J. Marta, fixed-income strategist with RBC Capital Markets.

"People are crawling out of their foxholes, there is money being put to work and the [mortgage] market is starting to come back," Marta said. "From a strategist's standpoint, I keep cautioning that the storm is still rolling on. There is risk that continues with the monolines."

JPMorgan equity analyst Andrew Wessel expects Ambac to raise its loss reserves for residential mortgage-backed securities by another $800 million, and incur another $1 billion in mark-to-market losses, in the next two quarters.

"We believe it will be at least another two to three quarters before Ambac will be able to get its arms around total expected losses," Wessel wrote in a recent research report.

Even New York State insurance superintendant Eric Dinallo said late last week that Ambac may need to raise more capital in the coming months. However, he said he has not approached the company about the issue or asked that they look into it.

In the event that Ambac does need to raise more capital, its ability to do so may be more constrained than the last time.

"The firm may find it difficult - given weakened financial flexibility - to quickly remedy further deterioration in its capital position if markets continue to worsen," Moody's said.

Last Monday, Ambac said it will ask shareholders to approve a near doubling of the number of authorized shares to 650 million, from 350 million, in an effort to gives itself some added financial flexibility. The authorized shares could be used to raise additional capital, though the company says there was no plan to tap the added capacity.

"Given that the cheapest way to raise capital is to do it internally, we can't issue shares" right now, Sharma said. "That's just the reality of the capital markets."

 

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