S&P Downgrades FGIC, CIFG and SCA... History of the Monolines

Hot on the trail of downgrading Ambac and MBIA, S&P just downgraded FGIC, CIFG, and SCA.

CIFG, stripped of its AAA rating in March, was downgraded further today to A-, while SCA's XL Capital Assurance Inc. and XL Financial Assurance Ltd. had their financial strength ratings cut to BBB-, the lowest investment-grade level. FGIC, owned by Blackstone Group LP and PMI Group Inc., had the BB ratings on its bond insurer placed under review for a possible downgrade.

I don't have access to their report but the reason quoted for some of their downgrades is quite lame. Take a look at one of reasons given for the the CIFG downgrade:

The downgrade on CIFG was centered around S&P's ``view that CIFG has lagged the industry in par volume in recent years and has generally failed to develop a strong franchise,'' S&P said.

Is it just me or does this basically say they don't know what they are doing? Are they just incompetent and can't evaluate credit? Developing a strong franchise? LOL That has been the case for a few years. If you are going to downgrade insurance strength ratings or bond credit ratings, they should really do it based on credit-worthiness of the business (or its ability to pay claims for insurance companies). All these excuses about franchise development, declining stock prices (in the case of Ambac and MBIA), and so on, just shows how little they know what they are doing.

Anyway, here is a historical look along with current S&P ratings (as far as I know):

As always, keep in mind that these are financial strength ratings of insurance companies, which is not the same as corporate bond ratings. Typically the corporate bond ratings are lower (for example MBIA and Ambac corporate bonds have never been rated AAA but their insurance subsidiaries have always had AAA rating--until now). Two thousand and seven looks like a distant memory given the changes. From 7 AAA-rated bond insurers down to 3 now (1 is a new entrant: Berkshire Hathaway Assurance). We will probably get another 2 AAA-rated bond insurers (one is already ready to go from a consortium formed by Macquarie bank from Australia; another will probably be from private equity). However, these players are likely temporary entrants who will leave if credit spreads narrow or if they can't control most of the market. I don't think any of these new insurers will underwrite structured financial products (given the debacle with subprime mortgages, it may be impossible for any muni bond insurer to write structured product insurance in the future). Management of Ambac also doesn't seem to believe in structured products but I think that's their only hope right now. But structured products have huge regulator risk, with the state regulators leaning towards the view that CDS-type insurance may not be true insurance. Capitalization of Connie Lee and various other muni-bond-oriented strategies seem short-sighted in my opinion. It might be even preferable to try to re-tailor the firm as a single-A or double-A rated reinsurer or niche insurer.

I don't like any re-capitalization or capitalization-dependent plans (like launching Connie Lee) because it will be dependent on the rating agencies again. They clearly have no idea what they are doing and are prone to changing their models at will. Now that they cut a deal with NY attorney general, Andrew Cuomo, with minor penalties, the government isn't going to pressure them to do anything further. It'll be interesting to see how the secrutization market (for asset-backed securities like student loans, credit card loans, auto loans, etc) functions without credible ratings from the rating agencies and insurance from any monoline.

(On an unrelated note, Moody's downgraded its outlook on Sears' corporate bond today from stable to negative. Bond rating of Ba1 was affirmed.)

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2 Response to S&P Downgrades FGIC, CIFG and SCA... History of the Monolines

June 8, 2008 at 10:12 AM

The arguments (or lack thereof) for the recent round of downgrades is what I find the most worrying, indeed disturbing. Are the rating agencies serious about this " a AAA is just what we want it to men, nothinh more nothing less" business? Ratings were supposed to be based on rigorous analysis, not fads and fluctuatig opinions.

How are investors to take ratings seriously if they can be changed depending on "a strong franchise, the stock price and financial flexibility, whatever that is".

I do think the rating agencies could be making themselves very vulnerable to a huge lawsuit. Not by the downgraded companies themselves, they need the rating agencies to much, but by (former) shareholders.

The rating agencies contracted with the insurers to provide a rating, which is supposed to be shorthand for the outcome of a thorough analysis of the company's ability to pay on it's obligations. The rating matters as many fixed income investors depend on it as a major (sometimes the only)method to assess a company. The rating agencies confirmed AAA ratings after additional capital was raised that the rating agencies believed might be needed in an extreme stress scenario.

This capital raise was very costly, especially for Ambac shareholders at the time who were seriously diluted. To strip the AAA rating now, without any material adverse change and with no clear argument (S&P even said MBIA has " strong claims paying ability) can be construed as not being done in good faith (especially with the rating agencies feeling pressure from the financial media where a lot of people "just know" the bond insurers will be bankrupt in a month or so.

I think there is a very real possibilty that the capital raises may prove unnecessary and Ambac & MBIA will be found never to have been in any danger. In that situation I see an opportunity for shareholders to make a case that the companies were damaged without any reason by the downgrades (and maybe the forced capital raise too). If the rating agencies acted merely in an effort to bolster their reputation among (currently bearish) pundits they may be liable for the resulting harm to shareholders interests.

Such a lawsuit would certainly not be an easy win (and as I am not well versed in US contract and securities law I really can't evaluate the merits to a satisfactory degree) but if shareholders can sue their own company for damages if misstatement are made that hurt shareholders I don't see why the rating agencies would be immune.

And S&P suddenly downgrading in what looks like a "me too" move isn't helping.

June 8, 2008 at 12:55 PM

ContrarianDutch: "I think there is a very real possibilty that the capital raises may prove unnecessary and Ambac & MBIA will be found never to have been in any danger."

The saddest thing is that that may be true (that may also be the case for many of the commmercial and investment banks that are raising capital). Even if it weren't true, raising the dilutive capital turned out to be completely useless given that Ambac and MBIA can't operate in the muni bond business without AAA, and there is no doubt about them paying their claims for the time being.

I think some responsibility lies with management for deciding to raise capital. They were completely wrong and did immense damage. I mean, I can't think of too many cases where management caused 66% loss in market cap (for existing shareholders) within a few months. Usually it takes fraud to wipe out 66% of book value for a mid-sized firm. In any case, the shareholders approved the plan (if my understanding was correct) so we are partly responsible.

I'm really curious to see what sort of hurdle they place on any new entrants (such as the bond insurer being launched by Macquarie bank and the new private-equity one that is rumoured to be launching). If FGIC is partly being downgraded due to "weak franchise" then these new entrants have zero franchise value. Are the rating agencies going to attach a franchise value to these entrants who have zero experience writing any bond insurance (Macquarie may have some limited experience but it'll be minor).

Overall, I don't think the rating agencies will be liable for anything. In fact, after their recent deal with the NY attorney they are likely immune to many of the accusations.

Rating agencies have always claimed that they are providing opinions and I think that's right (even though it doesn't help the Ambac situation or my investment). I recall vaguely that Moody's(?) was sued in the late 90's or early 2000's over some dubious ratings and the Supreme Court (or maybe it was the District court in the US) ruled that Moody's is simply excerising freedom of speech. I think the same thing applies to their ratings of all these structured products.

One thing that is working in our favour is that the capital requirements for the lower ratings are much lower (unless they change their models yet again :( ). It is going to get harder and harder to downgrade further. Now that Ambac has lost its AAA, even if it drops to AA- or A+, it has little impact. I don't want to see it but it's not as critical as losing the AAA. At those levels, you'll end up with some ridiculous numbers, where you have an insurance company with $15 billion in claims paying ability with zero liquidity risk. I think it will be hard for the rating agencies to downgrade the big two (Ambac and MBIA) below A+.

The rating agencies presently assume Great-Depression-like losses on mortgages and you really would be getting into some weird territory if you increased your loss estimates. Yes, you can have a more serious real estate bust now that the economy is slowing (eg. Japan in 1990) but the legal rights present in many of the insurance contracts (eg. super-seniority, ability to decide whether to acclerate payments, etc) should provide a shield.

Although I have been wrong about the rating agencies numerous times, I think they are unlikely to lower Ambac's ratings below A+ (or somewhere around there). Even now, the agencies likely know that they can't raise loss estimates without non-sensical results. That's probably why they keep referring to qualitative reasons such as weak franchise (for FGIC), or declining stock price (for Ambac and MBIA). Qualitative factors have always mattered but not to the degree being applied to the monoline insurers. If credit ratings were based on the performance of the stock price, practically every company's bond rating would be cut during every bear market (since stock prices of even the top companies decline substantially). That's dumb and the rating agencies would be the first ones to say it's dumb. So, I think they are just clutching at any reasoning that they can use. Qualitative reasons are easier to cite without backing up with anything (like I was saying, FGIC's franchise is no different now than 1 or 2 years ago (Ambac and MBIA still dominated the market and FGIC wasn't going to take the top 2 spot)).

Having said all that, if the rating agencies jack up muni bond losses, then I can see rating cuts being justified. However, they are not doing that. They keep talking about mortgage losses without really much change. Anyway, let's wait and see what S&P says in their rating downgrade report. I'm curious to see where Ambac's (projected) losses have increased. It looks like subprime CDO-squareds, CDOs and most direct RMBS have been modelled with big losses already; so my guess is HELOCs/CESes and CMBS (for MBIA). It is also possible they are projecting big losses in some "new" area like Alt-A or maybe high-grade CDOs.

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