Moody's Downgrades Ambac to Aa3 and MBIA to A2

As telegraphed a few weeks ago, Moody's just downgraded financial strength rating of MBIA insurance company from Aaa to A2, and Ambac Assurance from Aaa to Aa3. MBIA surplus notes were downgraded to Baa1, and the holding company rating to Baa2 from Aa3. Ambac's holding company rating was cut from Aa3 to A3. Click through for the details along with my comments...


Some interesting observations:

MBIA is cut one level lower than Ambac. However, as short-seller John Paulson has remarked at a Monaco hedge fund conference, Ambac is leveraged more to the residential real estate industry. This is primarily because Ambac is the biggest insurer of CDOs. But according to the stress tests from Moody's and S&P, MBIA is expected to post slightly higher losses due to HELOC/CES and commerical real estate exposure (Ambac has zero commercial real estate exposure.) Note that these agency numbers are purely theoretical estimates. MBIA also has slightly higher leverage as the following chart from FSA's 2007 presentation illustrates:




From a claims-paying point of view, the bond insurers have leverage similar to twice some of the highly leveraged investment banks (Bear Stearns was 25x to 30x or something like that). The bond insurers actually have some of the craziest leverage you will ever see in your life. Ambac, MBIA, FGIC, FSA, and even Berkshire Hathaway Assurance all have around 100x leverage.


By witholding around $900 million at the holding company, MBIA's holding company is strongly capitalized, and it can service its investment business better (this has nothing to do with bond insurance.) No doubt the short-sellers and their interests went livid upon hearing that MBIA was holding onto the money (for the time being) because most of the short-selling is done at the holding company level and bankruptcy becomes more of a remote possibility.

Moody's increased its estimated loss slightly. Moody's said that they increased their expected losses but the details are not clear. They also said that the portfolio amortization over the last 6 months cancelled out the losses. By doing nothing, the bond insurers lower their exposure and amortize more of their pre-paid earnings. This won't save the company from bankruptcy (since this won't make up for any huge loss) but it will pay for operating costs, lower the leverage, and so on.

Ambac plans to continue with its plan to capitalize a new insurance unit under Connie Lee. Ambac released a response to Moody's downgrade stating that. If I recall, Connie Lee is presently in run-off and is licensed in something like 40 states. I'm not a huge fan of this idea but it really depends on the details. I just don't want to see outside investors given lucrative deals that will harm the parent company in exchange for capital. Again, the short-sellers and others will be in the media bashing such a plan but if it can generate new business or if it can be used to re-insure downgraded muni bonds, I can see it working.



I'm going to quote a huge chunk of the press releases because I want to write it here for future reference (one of the reasons for starting the blog was to write down thoughts and reference key articles.)


MBIA Rating Downgrade

(source: Moody's downgrades MBIA's rating to A2; outlook is negative. Global Credit Research, Rating Action. June 19 2008. Moody's)

New York, June 19, 2008 -- Moody's Investors Service has downgraded to A2, from Aaa, the insurance financial strength ratings of MBIA Insurance Corporation (MBIA) and its affiliated insurance operating companies. In the same rating action, Moody's also downgraded the surplus note rating of MBIA Insurance Corporation to Baa1, from Aa2, and the senior debt rating of the holding company, MBIA, Inc. (NYSE: MBI) to Baa2, from Aa3. Today's rating action concludes a review for possible downgrade that was initiated on June 4, 2008, and reflects MBIA's limited financial flexibility and impaired franchise, as well as the substantial risk within its portfolio of insured exposures and a movement toward more aggressive capital management within the group. The rating agency said that while the group remains strongly capitalized, estimated to be consistent with a Aa level rating, and benefits from substantial embedded earnings in its existing insurance portfolio, these other business factors led to the lower rating outcome.

MBIA gets cut quite a bit. MBIA is getting downgraded primarily due to qualitative factors.

Based on Moody's revised assessment of the risks in MBIA's portfolio, estimated stress-case losses would approximate $13.6 billion at the Aaa threshold and $9.4 billion at the A2 threshold. This compares to Moody's estimate of MBIA's claims paying resources of approximately $15.1 billion. Moody's noted that its stress case estimates for MBIA's residential mortgage-related exposures increased by roughly $500 million to $5.9 billion, which was largely offset by insured portfolio amortization since year-end 2007. Relative to Moody's 1.3x "target" level for capital adequacy, MBIA is currently $2.6 billion below the Aaa target level and is $2.8 billion above the A2 target level.

Big cushion above A2 rating requirement so MBIA should be ok for a few more quarters (unless Moody's decides to downgrade based on some intangible factor again.)

The rating agency noted that MBIA's recent decision to retain at the holding company the $1.1 billion in proceeds from its most recent equity offering is indicative of a more aggressive capital management strategy, and is a negative credit consideration for the insurance company's rating. Such decision, however, puts the holding company in a strong liquidity position, said Moody's, providing additional comfort about the firm's ability to manage the effect of acceleration and collateralization in its GIC business triggered by the downgrade.

Ambac Rating Downgrade

(source: Moody's downgrades Ambac to Aa3; outlook is negative. Global Credit Research, Rating Action. June 19 2008. Moody's)

New York, June 19, 2008 -- Moody's Investors Service has downgraded to Aa3, from Aaa, the insurance financial strength ratings of Ambac Assurance Corporation ("Ambac") and Ambac Assurance UK Limited. In the same rating action, Moody's also downgraded the debt ratings of Ambac Financial Group, Inc. (NYSE: ABK -- senior unsecured debt to A3 from Aa3) and related financing trusts. Today's rating action concludes a review for possible downgrade that was initiated on June 4, 2008, and reflects Moody's views on Ambac's overall credit profile in the current environment, including the company's significantly constrained new business prospects, its impaired financial flexibility and increased expected and stress loss projections among its mortgage-related risk exposures relative to previous estimates. The outlook for the ratings is negative, reflecting uncertainties regarding the company's strategic plans going forward, as well as the possibility of further adverse developments in its insured portfolio.

Nothing surprising here...

Based on Moody's revised assessment of the risks in Ambac's portfolio, estimated stress-case losses would approximate $12.1 billion at the Aaa threshold and $9.6 billion at the Aa3 threshold. This compares to Moody's estimate of Ambac's total claims paying resources of approximately $15.4 billion. Moody's noted that its stress case estimates for Ambac's residential mortgage-related exposures increased by roughly $200 million to $5.6 billion, which was largely offset by insured portfolio amortization since year-end 2007. Relative to Moody's 1.3x "target" level for capital adequacy, Ambac is currently $225 million below the Aaa target level and is approximately $3 billion above the Aa3 target level.

It's never a pretty sight when shareholders get diluted massively (~66%) only to see a rating cut and $3 billion of excess capital. We paid a steep price. At least it gives a bigger cushion. I just hope that Ambac management doesn't fuck up and do something stupid.

Moody's will continue to evaluate Ambac's ratings in the context of the future performance of the company's risk exposures relative to expectations and resulting capital adequacy levels, as well as changes to the company's strategic and capital management plans as a Aa-rated company. Ambac has announced it intends to pursue opportunities in the public finance market through its Connie Lee Insurance Company subsidiary.

If anyone doesn't have enough topics to write about, they should follow the bond insurers. A day doesn't go without some form of action one way or another... If USA enters a depression, we are at the center of it; if not then this could be a once in a millenium investment opportunity (ok not really ;) )...