Junking of Ambac Puts Bonds in Limbo

By cutting Ambac Assurance Corp.'s financial strength rating to junk this week, Standard & Poor's put almost 26,000 municipal bonds into credit limbo.

Standard & Poor's on Tuesday slashed Ambac's rating to CC from BBB.

Moody's Investors Service followed suit late Wednesday, downgrading Ambac's insurance financial strength rating further into junk territory. Moody's cut Ambac to Caa2 from Ba3. It also downgraded the credit of Ambac Financial Group Inc.,  lowering its senior unsecured debt to Ca from Caa1. Moody’s outlook for Ambac is developing, and is negative for Ambac Financial.

The downgrades followed a statement Monday in which the New York-based bond insurer unveiled $2.4 billion in losses, froze the monthly dividend on its auction market preferred shares, and halted the interest payments on its subordinated capital securities.

Bad news for Ambac is bad news for two kinds of bonds: Ambac-insured debt with an underlying rating below triple-B, and Ambac-insured bonds with no underlying rating at all.

The rating of an insured bond is the greater of the insurer's rating and the underlying rating assigned to the issuer.

For issuers with stronger ratings than triple-B, the downgrade is not consequential. The issuers' ratings remain the same.

Ambac-insured issues with an underlying rating worse than triple-B have been downgraded to their underlying rating.

Standard & Poor's enacted 551 such downgrades late Tuesday following the Ambac downgrade, hitting such names as Youngstown, Ohio, West Haven, Conn., Niagra Falls, N.Y., and Scranton, Pa.

But the downgrade of Ambac delivered a greater wallop to issuers that opted not to obtain an underlying rating, thinking the rating from an insurer would suffice.

Standard & Poor's analyst David Veno said when the insurance on a bond with no underlying rating is cut to speculative grade, the rating agency's policy is to assign the bond no rating.

That is what happened to more than 25,500 bonds late Tuesday. Ambac's plunge pushed them from investment-grade into no rating.

Mary Talbutt-Glassberg, vice president of fixed-income portfolio management at Davidson Trust Co., said the issues downgraded to junk will run into trouble because many mutual funds by mandate may buy only investment-grade bonds.

The issues now designated "no rating," though, are in more serious trouble, she said.

"It's very difficult to sell a nonrated security on the Street right now," she said. "There are brokers who will not bid on them. I've had at least half of my municipal brokers say, 'No, we're not bidding on nonrated, because we can't move them.' "

In this category is the Jersey City Medical Center, a 644-bed hospital in that in 2001 sold $200 million in revenue bonds through the New Jersey Health Care Facilities Financing Authority to buy land and build a new hospital.

At the date of sale, based on Ambac's rating, Standard & Poor's rated the bonds AAA. Today, they have no rating from the agency.

The same is true for the California Infrastructure and Economic Development Bank. It sold $750 million in bonds in 2004 to raise money to pay workers' compensation claims.

Though it obtained underlying ratings from Fitch Ratings and Moody's Investors Service, the infrastructure bank did not obtain an underlying rating from Standard & Poor's, which now has no rating on the deal.

The downgrade of Ambac concerns its policyholders' surplus, meaning assets in excess of liabilities.

State regulators require the company to maintain a policyholders' surplus of at least $2 million. At the end of the first quarter, Ambac's surplus was almost $373 million.

Standard & Poor's believes with losses on mortgage bonds and collateralized debt obligations mounting, the surplus as of the end of the second quarter probably will be a deficit.

A spokesman for Ambac had no comment.

The double-C rating reflects the possibility the insurer will be seized by regulators, Veno said.

The company has appealed to the Wisconsin state insurance commissioner for permission to release some of its contingency reserves, which would contribute to its surplus.

Veno said if Syncora Holdings Ltd.'s experience is any indication, regulators will only allow Ambac to use some of its $1.9 billion in contingency reserves to bolster policyholders' surplus. And even then, its capital position still might not be strong enough, he said.

Standard & Poor's said it could upgrade Ambac if it wins permission to use contingency reserves, to no higher than CCC.

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