Thursday, June 19, 2008 10 comments ++[ CLICK TO COMMENT ]++

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 ;) )...

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10 Response to Moody's Downgrades Ambac to Aa3 and MBIA to A2

synchro
June 20, 2008 at 2:25 PM

Several sectors are already in a depression. Auto and homebuilding would be two of them.

Btw, Legg Mason Value Trust took a plunge in its NAV yesterday. Then I realized they probably just did a mid-year capital gains distribution. If that's indeed a case, that's quite a distribution -- sort of adding insult to injury in the sense that the sharesholders are not only losing money on their 1.70%-per-year mutual fund, now they also have to pay a hefty capital gains/income tax on the distribution.

Wonder if some of the shareholders are throwing in the towel on Miller, so that he is forced to sell his clunkers to raise cash?

contrariandutch
June 20, 2008 at 3:50 PM

MBIA seems to be getting "punished" for not moving the $900 million to the insurance subsidiary, even though by Moody's own numbers actually moving the cash there would have no effect on capital adequacy whatsoever. Still, better speed up that new subsidiary idea provided the rating agencies don't decide to rate it CCC in advance just because they can. Any attempt to keep the existing subsidiar a going concern is now hopeless.

MBIA debt is trading at less then 65% of par, buying some back could save a lot of cashflow.

Ambac should power up Connie Lee as a specialist muni subsidiary I think and reinsure the existing muni bonds with it. The regulators will almost certainly like it (and may twist the rating agencies arms enough to stop them from only listening to the bears blaring in their ears so Connie can actually keep the AAA). Also, if the original subsidiary does get sunk a good chunk of value could be saved.

Ambac should be able to capitalize Connie from already availabe resources given that they are quite far above AA capital requirements (and could just let the rating get shot to hell anyway if Connie starts doing the business). Drawing addititional outside capital might be usefull, but only if the price is right. Still, given the price where AGO trades, I am tempted by the idea of floating a small part of Connie to make the embedded value clear to the naysayers.

June 20, 2008 at 6:31 PM

SYNCHRO: "Several sectors are already in a depression. Auto and homebuilding would be two of them."

As Martin Whitman was saying several quarters ago, resilient economies like the US have faced several depressions in various sectors over the years. I would agree with you that homebuilding will be in a depressed state for a while (not sure about autos; autos seem to have been in far worse shape in the 80's than now). The steel industry was in a depression in the 90's; oil&gas in the 80's; tech industry in the early 2000's (I can speak firsthand); and so forth.

The real question...then...is whether we will get depression in all industries. I just don't see it. The only way I see us entering a depression is due to some policy mistake. If Bush invades Iran (Israel carried out a war games recently to threaten Iran); or if Obama or McCain (future administration) slaps on a tariff on China; or something dumb like that; then it can get bad. Otherwise, I just don't see it...

"Wonder if some of the shareholders are throwing in the towel on Miller, so that he is forced to sell his clunkers to raise cash?"

I'm sure people have been selling over the last few years. I still believe in him and this doesn't mean anything to me. I mean, Jean-Marie Eveillard and Martin Whitman have mentioned in the past how their funds got clobbered in the late 90's (due to dot-com bubble). Even right now, Whitman says he has been increasing cash to accomodate massive withdrawls (if it comes to that).

June 20, 2008 at 6:33 PM

ContrarianDutch,

Wouldn't it be safer to wait a few quarters and see how if there are any further, sizeable, losses? By keeping a big cushion, you can handle any blows. If you go with the Connie Lee idea (assuming it works out), Ambac will simply be slightly above the limit and will get cut further. Although further rating downgrades (assuming small) won't matter much, I would rather avoid it.

contrariandutch
June 21, 2008 at 5:22 AM

Sivaram,

Moody's has made it very explicit that no amount of capital can save MBIA & Ambac ratings at the moment. MBIA is well above AA level yet gets cut all the way to A "because it intends more agressive cash management". WTF? What Moody's is really saying is:

"Market really hates you guys and all the bearish commentators are growling down our necks for not cutting your ratings so we will just be pleasig the furry crowd and hope they concentrate on you again". (Didn't even have the decency to say "sorry, gotta save our own asses"). I agree with Tom Brown, they really deserve a massive lawsuit.

The way the rating agencies are arguing right now we will see a cut to B- " because it is more in line with expectations in the market and having AA capital level isn's relevant because the bears don' understand that anyway" (I am amazed at the financial illiteracy betrayed by many bearish commentators).

The existing insurance subsidiaries are toast. There are just to many interest out there that will not let them write a single new contract. Time to get out as much money as possible and start over. Waiting only makes things worse at the moment. Retaining staff will get more difficult and time allows competitors to entrench. Since capital is largely irrelevant to ratings anyway (at least for Ambac & MBIA), use it for something profitable instead. Get out everything above the minimum for current ratings and make it useful to shareholders. Let the existing subsidiaries go into runoff if that is what everybody insists on.

June 21, 2008 at 12:29 PM

Hi ContrarianDutch...

Even if you start a new insurer, reputation is really low and new business will be limited. You will avoid losing employees, etc... but...

My thinking for the 'wait' strategy is based on the possibility of mark-to-market losses reversing later in the year or maybe early next year. The marks aren't used for loss projections but that is what is killing the market opinion of the monolines (and hence pressuring the rating agencies, regulators, and others). Although Tom Brown is way too optimistic, even if his thinking is correct to minor degree, the projected mortgage losses are going to end up looking high. Do you see the possibility of the market (which is what is what dictates the markt-to-market prices) changing its loss expecations within an year? Or will it take much longer?

One of arguments is that it'll be hard to get back the AAA rating (check out the linked David Merkel argument). I think that would be true in most cases. But if the marks reverse, the monolines will end up with a huge amount of capital. Is there a possibility of ratings being upgraded if that scenario unfolds? Or do you share David Merkel's view that this may be the end of the structured finance insurance and the rating agencies simply won't give an AAA to any monoline involved in that business?


Anyway, it looks like Ambac, MBIA, et al, are pursuing with the 'new insurer' idea. Given our limited choices, I am not too opposed if capital injections (if needed) don't massively dilute any of the viable portion of this company.

(oh one other thing... floating a new company (I think you mentioned this possibility) is very risky. It's going to come under attack by short-sellers so it's better to keep it under wraps. I mean, even FSA, AAA-rated and backed by a big bank, is being threatened.)

contrariandutch
June 21, 2008 at 3:06 PM

Sivaram,

I expect marks to market to begin reversing in the second half of this year as the eventual size of mortgage related losses becomes more clear and RMBS can be priced accordingly (note that price deterioration has already largely stopped as per Ambac's april numbers). Current prices are driven by fear and price in ultimate losses that are literally unbelievable (similar to the $1.3 trillion loss projection of Paulson losses in excess of those experienced during the Great Depression are expected). I agree with Tom Brown, and don't think him excessively optimistic, that the US real estate mess is stabilizing. Once uncontrolled fear subsides marks to market will improve.

However as the rating agencies have made it quite clear that capital adequacy is not what is driving these downgrades I expect little positive effect in that quarter from an improving capital positon. (the share price is a different matter, just posting a quarter with only a modest loss would probably be enough to trigger a strong rally given the current negativity).

As for an improvement of market opinion, if marks to market reverse the real bears will just say that management is lying and the companies will be bankrupt real soon now. It will take time for the media/blogospere to cease fire.

The existing insurance subs cannot be salvaged I think, at least not for several years. Their ratings are gone and will not come back quickly (esp. at MBIA, Moody's can hardly say Oops! in a few months and put the AAA back, Ambac is still AA and could be back to AAA more quickly once the extend of the RMBS losses becomes known). A fresh company, with no structured taint whatsoever would be in a very different position. The rating agencies would be hard pressed to explan why it can't get a AAA and regulators (who seem to really like this as a way to separate the muni bonds) seem t like the idea too. Regulatory pressure might just be enough to get the rating agencies to cooperate a bit.

While I am comfortable with the investment in a runoff scenario I think the companies are worth considerably more as going concerns, especially as I am rather optimistic about the sales opportunities for bond insurance. So I like measures that make that scenario more likely.

In addition, I think the biggest risk is that the holding companies may end up insolvent (the bears are very actively working to make it happen)even if the eventual losses are not so bad (bigger risk at Ambac). Getting a healthy sub (that can provide income to holding) going ASAP would help prevent that scenario.

Last but not least, I think stuctured credit insurance has a future. Prices should be much better and pricing models too and the market is huge. And let's not forget that the monolines can yet make money from the dreaded RMBS/CDO business. Well over half their 2006/2007 income comes from that source. It would be the ultimate irony if losses on these contracts in aggregate are smaller then premiums received (On the basis of the monolines own loss projections, this could happen!)

Structured credit insurance and maybe reinsurance are the only kind of business I see the existing insurance subs write for at least three years. I think it would be better to do that business in dedicated subs anyway. Less baggage. Waiting three years or more effectively puts you in runoff and remerging will be very hard and I really fail to see what waiting a few months would accomplish over getting a new sub going right now.

(I suspect I am rambling, am I?)

contrariandutch
June 21, 2008 at 3:06 PM

Sivaram,

I expect marks to market to begin reversing in the second half of this year as the eventual size of mortgage related losses becomes more clear and RMBS can be priced accordingly (note that price deterioration has already largely stopped as per Ambac's april numbers). Current prices are driven by fear and price in ultimate losses that are literally unbelievable (similar to the $1.3 trillion loss projection of Paulson losses in excess of those experienced during the Great Depression are expected). I agree with Tom Brown, and don't think him excessively optimistic, that the US real estate mess is stabilizing. Once uncontrolled fear subsides marks to market will improve.

However as the rating agencies have made it quite clear that capital adequacy is not what is driving these downgrades I expect little positive effect in that quarter from an improving capital positon. (the share price is a different matter, just posting a quarter with only a modest loss would probably be enough to trigger a strong rally given the current negativity).

As for an improvement of market opinion, if marks to market reverse the real bears will just say that management is lying and the companies will be bankrupt real soon now. It will take time for the media/blogospere to cease fire.

The existing insurance subs cannot be salvaged I think, at least not for several years. Their ratings are gone and will not come back quickly (esp. at MBIA, Moody's can hardly say Oops! in a few months and put the AAA back, Ambac is still AA and could be back to AAA more quickly once the extend of the RMBS losses becomes known). A fresh company, with no structured taint whatsoever would be in a very different position. The rating agencies would be hard pressed to explan why it can't get a AAA and regulators (who seem to really like this as a way to separate the muni bonds) seem t like the idea too. Regulatory pressure might just be enough to get the rating agencies to cooperate a bit.

While I am comfortable with the investment in a runoff scenario I think the companies are worth considerably more as going concerns, especially as I am rather optimistic about the sales opportunities for bond insurance. So I like measures that make that scenario more likely.

In addition, I think the biggest risk is that the holding companies may end up insolvent (the bears are very actively working to make it happen)even if the eventual losses are not so bad (bigger risk at Ambac). Getting a healthy sub (that can provide income to holding) going ASAP would help prevent that scenario.

Last but not least, I think stuctured credit insurance has a future. Prices should be much better and pricing models too and the market is huge. And let's not forget that the monolines can yet make money from the dreaded RMBS/CDO business. Well over half their 2006/2007 income comes from that source. It would be the ultimate irony if losses on these contracts in aggregate are smaller then premiums received (On the basis of the monolines own loss projections, this could happen!)

Structured credit insurance and maybe reinsurance are the only kind of business I see the existing insurance subs write for at least three years. I think it would be better to do that business in dedicated subs anyway. Less baggage. Waiting three years or more effectively puts you in runoff and remerging will be very hard and I really fail to see what waiting a few months would accomplish over getting a new sub going right now.

(I suspect I am rambling, am I?)

June 21, 2008 at 5:50 PM

Thanks for the post ContrarianDutch. I don't find it rambling at all; and in fact find it insightful on many issues.

If it takes 3 years for changes to result in ratings (upgraded back to AAA) or for the the business to be able to write new business, then that strategy isn't worth it. So, I would concur with your view that waiting won't do anything.

My expectation was for everything to settle down one way or another by the end of this year. But I see what you are saying in regards to changes in the future. Even if losses stabilize and don't get worse, I see your point that the rating agencies won't be compelled to do anything. They have no incentive and now that they have cut a deal with the New York Attorney General, I think they don't care one way or another.

After reading your post, I'm leaning more towards the Connie Lee capitalization idea. I still want to see the details before agreeing with it (not that my small shareholding has any impact.)

I guess we just need to wait and see what management comes up with.

June 21, 2008 at 10:49 PM

One problem I see with Connie Lee is that it is a subsidiary of Ambac Assurance, not the holding company. So, I don't know if it will improve the situation at the holding company. In contrast, whatever MBIA is pursuing is a direct subsidiary of the holding company... I don't know if Connie Lee can be moved to under the holding company or not (probably not :( )...

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