Ambac Smacked With Downgrade

The bond insurer loses its pristine triple-A rating after dropping plans to raise $1 billion.
Publish date:

Updated from 10:44 a.m. EST

Fitch Ratings levied more bad news on the financial guarantor

Ambac Financial


on Friday, cutting its critical triple-A rating.

The rating agency slashed the premium triple-A rating to double-A for Ambac Assurance Corp., Ambac Assurance UK Ltd. and Connie Lee Insurance Co. and cut holding company Ambac Financial Group from double-A to single-A.

The ratings action comes after Ambac said it was abandoning plans, unveiled just Wednesday, to raise $1 billion. On Thursday, Moody's Investor's Service also threatened to cut the troubled bond insurer's rating as well, sending its stock plummeting along with that of larger peer insurer


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Ratings are critical for bond insurers such as MBIA and Ambac, who must use their high credit rating to underwrite insurance contracts and backstop losses on debt from municipal bonds to more complicated structures such as collateralized debt obligations and mortgage-related securities. Bond insurers as a group insure some $2.5 trillion in debt that is held by pensions, insurance companies and big banks, including

Merrill Lynch




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The real jeopardy about ratings cuts in the monoline bond insurance sector is the

implications for big banks and counterparties that hold contracts insured by Ambac and MBIA. Bill Gross, CEO of bond shop Pacific Investment Management Co., has speculated that losses tied to bond insurers and the firm's they hold insurance for could be an otherworldly $250 billion.

Ambac's stock has been leveled over the past several days as news of further writedowns in its debt portfolio have come to light. The stock was

down nearly 52% on Thursday, but saw investors take a more positive tone when the insurer decided to nix the plan to raise $1 billion in new capital in favor of underwriting no new business and collecting payments from its existing pool of contracts. Shareholders had groused that the planned capital raising efforts -- a move to kowtow to the fickle rating agencies -- would dilute Ambac's outstanding equity.

Ambac's shares were up for the better part of Friday by as much as 8.2% on the news of its plan. After Fitch's downgrade, it was still up around 9.3% at $13.62. MBIA shares recently were down around 7.8% to $8.50 on Friday, after shedding 31% on Thursday.

A spokesman for MBIA declined to comment on the ratings moves, including an announcement earlier by Moody's that would revisit a review of MBIA's balance sheet even after affirming the insurer's rating a month ago. A call to an Ambac official was not immediately returned.

Fitch Ratings late last year warned Ambac and MBIA that if the insurers didn't raise $1 billion by late January, they would be downgraded. The ratings agencies have been accused of being late to respond to the mortgage debacle that has been at the root of the entire financial calamity.

Ratings firms have also seemed to flip flop between endorsing the lofty ratings of these insurance shops and then reversing course, even after conducting months of due diligence on their balance sheets.

The wild ratings process suggests that either these bond insurers are being less than forthcoming with the rating firms, the securities and underwriting methods are too hard to parse, the rating agencies are somehow inept -- or all of the above.

What's equally concerning is the jousting taking place between the ratings agencies and the bond insurers.

Ambac, in a terse statement Friday in which it announced it was abandoning the plans to raise capital, said "it remains confident in its insured portfolio and will communicate further on these matters in its previously scheduled conference call on Tuesday, Jan. 22."

Earlier this week, Ambac said it would

slash its dividend and raise $1 billion in an effort to maintain its triple-A rating. On Friday, it said market risk and "recent actions of certain ratings agencies" -- an overt reference to Moody's -- changed those plans. The company continues to evaluate its alternatives, it said.

MBIA, in a statement Friday morning, said it was "surprised" at Moody's action, given the rating agency last month said MBIA had "reestablished a robust capital position" and expected to revise its outlook to stable. Fitch on Wednesday had removed MBIA from its rating watch negative list and changed its outlook to stable.

"We have developed and are implementing a comprehensive capital strengthening plan in good faith reliance on Moody's stated requirements," MBIA Chairman and CEO Gary Dunton said in a statement Friday, citing a plan that would inject as much as a $1 billion into MBIA. "We believe our capital plan meets or exceeds the requirements previously outlined by Moody's and the other two major rating agencies."

The question that stands out now is will other rating agencies now follow suit and downgrade Ambac -- and take a harder line on the other monolines. A call to Standard & Poor's and Moody's was not immediately returned.

So far, the only monoline to see its ratings chopped down have been ACA Capital -- a New York-based debt insurer that for its short time in the business has managed to underwrite some of the riskiest paper on Wall Street. Ratings on that firm were downgraded by S&P from single-A to junk status triple-C. ACA, as outlined in a

Wall Street Journal

article Friday, is in a mad dash to secure grants of forbearance from its creditors and insureds so that it can conduct an orderly unwind of its portfolio.

The downgrades forced Merrill Lynch, which on Thursday reported a woeful fourth-quarter loss of $9.83 billion along with billions in debt writedowns, said that it had to take additional writedowns due to the ACA downgrade.

Merrill's roughly $3 billion writedown tied to ACA is big number, but pales in comparison to outsized amount that it has endured on bad mortgage paper. If the much larger firms such as MBIA and Ambac suffer a similar fate, however, the entire market could buckle.

Josh Rosner, managing director at research firm Graham Fisher in New York told

the monoline problems could be a jagged pill to swallow for some of the major firms, because they act as counterparties, providing additional protection for investors in the form of derivative securities known as credit default swaps.

In this shaky economic environment it has been easy to take the bearish gloom-and-doom posture, but the implications could make the subprime collapse look minor by comparison.

Is it likely that these firm's could go bankrupt? Let's hope not, but there are investors including Pershing Square's Bill Ackman that are not only predicting a monoline collapse but also

betting on just that. Ackman stands to generate billions in fat profits if Ambac and MBIA go under.

The rest of the market, including bigger mortgage firms such as

Fannie Mae



Freddie Mac


, who also use bond insurers, however, may be facing quite a bit of disarray.