Ambac Financial Group has become the first AAA'-rated monoline to be downgraded by a rating agency, igniting a wave of rating actions for bonds wrapped by the insurer.
But the ultimate impact of Ambac's write-downs, which sparked the downward rating action, appears to be manageable, at least for now, market participants said.
On Jan. 18, Fitch Ratings cut Ambac's 'AAA' insurer financial strength rating two notches to AA'. The insurer also had its senior unsecured debt downgraded two notches to A' from AA'.
As a result of the downgrade, Fitch cut the ratings on 420 classes of Ambac-insured ABS bonds that remain on Rating Watch Negative.
Rating actions were also taken on 137,504 bond issues - 137,390 municipal and 114 non-municipal (largely corporate and emerging market) - that were insured by Ambac. Issues with underlying ratings higher than Ambac's will remain above the bond insurer's level, Fitch said. The rating agency added that 261 Ambac-insured issues will remain at 'AAA', 757 issues will remain at 'AA+', and 155 issues with a 'AA' underlying rating are not on Rating Watch Negative.
But while the downgrade is significant, if the insurer's rating stays at AA', the impact to the market will not be as severe as the case of ACA Capital, market participants said. ACA had its 'A' financial strength rating cut to 'CCC' in mid-December by Standard & Poor's, causing large write-downs at banks like Merrill Lynch and CIBC.
Effect on Europe
In Europe, Fitch Ratings' downgrade of Ambac last week opens the door for further negative rating activity. According to Deutsche Bank estimates, the insurer provides primary guarantees on around 17 billion of European structured finance outstanding, including mostly future flow, project and corporate securitizations as well as certain older vintage nonconforming RMBS from GMAC-RFC's RMAC series. AMBAC's role as a secondary protection seller in the European ABS market is expected to be an even bigger threat to credit market technicals. The monoline has reported that non-U.S. net par exposure, including CDS contracts, amounted to roughly 55 billion at the end of 3Q07.
Increased Credit Analysis
While there will be valuation adjustments made to securities wrapped by the bond insurer, historically, most wrapped securities have not needed to call on the guarantor to make a payment. This standard should hold true for sectors away from the troubled parts of the market such as second lien mortgages, said Kathleen Shanley, an analyst at Gimme Credit. Shanley noted that investors are going to be called upon to do more credit analysis of the underlying securities and the market will probably see varying impacts on pricing depending on the underlying quality of the wrapped asset.
However, the future is not too bright for the insurer. Last week, Ambac announced a fourth-quarter 2007 net loss of approximately $3.3 billion, primarily due to non-cash, mark-to-market losses on credit derivative exposures that totaled $5.2 billion. The monoline amended the terms on its revolving credit facility with Citigroup last week though no further information was provided in the company's Securities and Exchange Commission filing.
Most monoline insurers' credit default swap spreads as well as share prices have tumbled, according to analysts at UniCredit, who noted that Ambac's market value was down 93% at the beginning of last week.
Ambac Assurance Corp. has its insurance financial strength, credit enhancement and issuer credit ratings on CreditWatch with negative implications by S&P. At the same time, the rating agency put Ambac Financial Group's senior unsecured, issuer credit and hybrid security ratings on CreditWatch with negative implications. Moody's Investors Service also has Ambac Assurance Corp. and Ambac Assurance UK on review for a potential downgrade, which also holds true for Ambac Financial Group and its related trusts. Calls to a spokesman for Ambac were not returned by press time.
Reflection of the Future
Ambac's case is merely a reflection of recent events in the bond insurer industry. Without a bailout by either banks or politicians, it's unlikely that monolines will retain their triple-A rating. "Now that the first downgrade has gone through, it will become much easier for the other agencies to follow suit with other monolines," Royal Bank of Scotland analysts said.
As evidence, even after raising additional capital, MBIA saw its ratings placed on review for a possible downgrade by Moody's.
"We now believe that there are no public markets open to the monolines in their quest to raise capital," RBS analysts said. "Confidence has collapsed and investors are unlikely to be willing to inject more capital. Only the passage of time (and therefore clarity on losses) will enable investors to start to trust in the credit quality of the monolines again. Without that confidence the insurers will have no choice but to cut back new business dramatically."
Adding to the monoline sector's troubles, late last week Fitch Ratings downgraded Security Capital Assurance's (SCA) insurer financial strength rating to A' from AAA,' along with its subsidiaries XL Capital Assurance, XL Capital Assurance (U.K.) and XL Financial Assurance.
The rating agency also slashed SCA's long-term issuer rating to 'BBB' from 'AA' and its fixed/floating series A perpetual non-cumulative preference shares to 'BBB-' from 'AA-.'All ratings are on Negative Rating Watch.
The downgrades were prompted by SCA's recent announcement that it would not raise new capital due to current market conditions. SCA said it is still looking to raise capital through reinsurance arrangements and restructuring certain insured obligations.
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