Ambac, MBIA: The Rating Shoes Drop

Lack of confidence in the ability of bond insurers’ to maintain triple-A ratings has now given way to unwarranted concern about the solvency of these companies. The Regulators in New York for MBIA (MBI) and Wisconsin for Ambac (ABK) have repeatedly said they have no concern about the ability of Ambac and MBIA to pay current and future claims and the rating agencies agree, since their rating opinions now converge around double-A to single-A levels. 

State bond insurance regulations are formulated and enforced for the sole purpose of protecting the interest of policy holders i.e., the ability to pay claims. Rating agency rating opinion gradations at any point in time do not drive regulatory action. These parties are consonant only when both conclude the ability to pay claims is in doubt. In rating agency speak it means a non investment grade rating (double-B or lower). Regulators use one or more of several control interventions. Do you know or care about what the credit ratings are on your homeowners or auto insurance companies? 

Loss of the market’s confidence and confirming rating downgrades has hurt shareholders much more than policy holders (the owners of insured Ambac and MBIA bonds). The default protection remains, however, and that protection may be undervalued now in the tax exempt market; there is only upside potential.  

Moody’s (MCO) and S&P (MHP) are now weighing the inability to write a significant level of new business and a very constrained ability to raise capital on par with capital resources necessary to support a particular claims paying rating. In light of these developments, it seems to me that MBIA’s decision to not downstream money to its insurance subsidiary was a rational choice. 

It is interesting to note that Moody’s, for instance, modestly increased stress case loss projections for both insurers that was offset by exposure runoff since their last projections. On a capital sufficiency basis, Moody’s pegged MBIA at double-A and Ambac as exceeding the triple-A target level.  

In any event, whether you agree or disagree with the Regulators and Ratings Agencies, the prognosis for the Companies should be clear by the time 4^th quarter results are posted. 

Why Clarity by January 2009? 

The collapse of mortgage underwriting standards drove, on an income adjusted basis, residential real estate prices in the most recent bubble well beyond levels of the prior late 1980’s real estate bubble. It should be no surprise then that the near overnight restoration of mortgage standards would trigger unprecedented velocity of price correction. As a result, clarity as to peak to trough real estate prices and mortgage loss expectations for insurers and the real estate market in general should be evident sooner rather than later. For more on this point, you may wish to review “U.S. Housing: The Big Picture by the Numbers” Seeking Alpha March 27, 2008.

Comments

[Ishortyou:]

In respect to AMBAC and MBIA, they need to keep and save all the cash possible including stop paying dividends, deleverage from all their risky liabilities specially those CDS, CDO's, RMBS-ABS of uncertain value, in order to remediate their book values, once their book values are sound they need to reinstate their triple A rating again to write new low risk public bond insurance business. They can also open or extend a line of credit to make sure to continue operations and dissipate doubts.

They are already doing these, so it will take some time to deleverage their books from uncertainties and rewrite new business again. This coming back will be the best advertisement to recruit new clients.

2008 Jun 24 06:10 AM

[crashof2008:]

This is absurd. Did it ever occur to you that the historical volatility assumptions used in modeling the "value" of MBI's CDOs are completely irrational? Do you even know anything about the whole historical vs. implied volatility valuation debates for derivatives?

Duh.

Maybe if you had taken more than elementary algebra you would understand that MBI is truly, irrevocably bankrupt.

See you in January, when FASB 163 takes full force.

2008 Jun 24 07:17 AM

[Ishortyou:]

banks are running out of options for cash flow, now that their equity is licking the floors, they are going to get the cash flow from the foreclosures, the foreclosures are going to be the cash driving force for the next quarters to come, they already are doing that, just look those fire sale foreclosures in the current market, at least that would help to get of rid of those housing inventories the sooner the better.

2008 Jun 24 07:58 AM

[crashof2008:]

Enter your comment hereSome of you have heard about MBI and ABK attempting to cancel 125 billion in credit default swaps in intense negotiations with Citibank, Merrill and UBS. Most accounts put MBI's share at 80 billion of this.

Any negotiations to cancel the 80 billion in insurance contracts that MBI wrote will be extraordinarily problematic, especially in this environment of collapsing bank profits.

To understand why, you need to master the difference between a CDO and a CDS. The difference between these two is an absolutely VITAL distinction that so many overlook.

I'll keep it short and sweet. But you need to master this distinction. Read carefully for just 30 seconds and it will serve you well.

Think of a CDS (credit default swap) as an insurance policy. MBI insured 80 billion of largely worthless paper to various banks. They are, after all, an insurance company and thought this would be a logical extension of their insurance business.

Now MBI wants the banks such as Merrill and Citi and UBS to cancel the insurance policies. MBI is basically offering to simply refund the premiums paid.

This would leave the banks holding 80 billion dollars of collateralized debt obligations (CDOs) that had been insured and guaranteed by MBI.

It's like if your house is destroyed in a fire. The insurance company, instead of reimbursing you for the value of the home (say $400,000) offers instead to rebate you the $1200 you have paid in premiums.

Would you take it?

This is what MBI is offering.

2008 Jun 24 09:48 AM

[fxtrader07:]

@crash: ignore the many substantial counterpoints to your doomsday scenario at your own peril. From a Bk/solvency point of view i would say there are 90% of the NYSE stocks more endangered than MBI and ABK.
The sky will not be falling anyway and the American economy as well as the stock markjet will muddle through a few difficult years. but other sectors of the economy and the stock market are certainly to face more headwinds than ABK/MBI going forward. they had their pain and are more or less done with at this point.

2008 Jun 24 10:46 AM