Insurer Of Bonds Loses Top Rating
Saturday, January 19, 2008
NEW YORK, Jan. 18 -- Ambac Financial Group, the nation's second largest insurer of bonds, lost its precious AAA rating from Fitch Ratings on Friday over concerns that the company no longer had enough capital to guarantee billions of dollars in debt now imperiled by the subprime mortgage crisis.
The move to downgrade Ambac to a rating of AA could further roil financial markets, increasing pressure on Wall Street banks that hold this bad debt and making it even more costly for local governments to raise money for public projects.
Ambac and other bond insurers play an obscure but crucial role in capital markets by essentially transferring their ratings to the securities they guarantee. The downgrade of Ambac means many of those securities also will be downgraded, Fitch said.
This could spark a substantial sell-off by institutional investors such as pension funds that can only invest in top-rate securities, causing their value to drop. That in turn would prompt even more selling. As the securities become less valuable, Wall Street firms could be forced to write down billions of dollars on their balance sheets, restating how much their holdings of these securities are worth. The banks, which have already suffered staggering losses, have relied heavily on bond insurance to reduce their exposure to subprime mortgage debt and other complicated securities linked to these loans.
"Everyone thinks they're looking at the cliff over Armageddon," said Ed Rombach, senior derivatives analyst at Thomson Financial. "If you think the write-downs have been bad so far, the next write-downs could be twice as big."
The downgrading of Ambac is also a major blow to municipalities and other government authorities, which are having difficulty raising money for roads, buildings and other projects because of the worsening credit crunch. Some government agencies may find borrowing more costly, while others may not be able to raise money at all.
The troubles of Ambac and other bond insurers are rooted in their decisions during the last decade to move beyond their traditional business of insuring municipal debt into a realm of complicated securities. Much of this was made up of structured debt entailing subprime mortgages.
In downgrading Ambac, Fitch said its decision "reflects the significant uncertainty with respect to the company's franchise, business model and strategic direction."
The move by Fitch, one of three major rating agencies, came hours after Ambac said it would abandon its plans to raise $1 billion in capital. The rating agency said last month that it considered the additional capital as critical. Fitch gave the company no more than six weeks to come up with the funds.
Ambac had said Wednesday it would strengthen its capital base by issuing at least $1 billion in securities. A day later, however, the company said it expected to report a loss of $5.4 billion on its portfolio of credit derivatives and losses of another $1.1 billion on subprime mortgage securities. Ambac also announced its chief executive, Robert J. Genader, had resigned. That same day, Moody's Investor Service signaled it was also considering whether to downgrade Ambac's ratings. Ambac stock plunged 52 percent.
On Friday, the company did an about-face, announcing that "market conditions and other factors" had made raising capital "not an attractive option at this time."
Fitch was out of patience. "There's no reason to wait any longer," said Thomas Abruzzo, managing director at Fitch, in an interview after Ambac was downgraded.
Ambac declined to comment on the decision.
In recent months, shares of some of the biggest bond insurers have been pummeled as rating agencies scrutinized the insurers' ability to cover potential defaults on the mortgage-related bonds they insure, particularly those backed by loans to homebuyers with poor credit. In total, Ambac and six other AAA-rated bond insurers enhance the credit of some $2 trillion worth of debt securities held by Wall Street banks, pension funds, mutual funds and other investors around the globe.
Without its flawless rating, Ambac may now find it nearly impossible to attract business, analysts said. Rombach and others questioned whether Ambac could even stay afloat. Some analysts said the move by Fitch would trigger downgrades by the other two major credit rating agencies, Moody's and Standard & Poor's, which have been reviewing the ratings of Ambac and its peers.
"The Fitch downgrade only exacerbates Ambac's difficulties in their ability to write business as well their ability to access capital or other capital-like instruments," said Dick Smith, managing director of global bond insurance ratings at Standard & Poor's. He said S&P was already focused on those issues as it conducts its review.
Moody's warned Thursday it was also reviewing the ratings of MBIA, the largest bond insurer, citing "growing concern about the potential volatility" in the performance of mortgage-related securities and "the corresponding implications for MBIA's risk-adjusted capital adequacy." Moody's decision came even after MBIA had carried out its own $1 billion debt issue.