What Should Ambac's Connie Lee Be Rated?

Just a short post, but there are two reasons why Connie Lee should not get a AAA from the rating agencies (Aaa if you speak Moody’s):

1) It violates their notching standards.  A parent company (ABK) with a senior unsecured debt rating of A/A3 should only get ratings of AA/Aa3 maximum.  This is because a holding company can only provide so much incremental support to a subsidiary, so the degree of enhancement to a well-capitalized subsidary should only be three notches, particular given that there may come a time when the parent company is incapable of adequate support, and the subsidiary is in need as well.

Connie Lee is a small insurance company with a weak parent company.  Small insurers always get weaker ratings than large insurers, unless they have a deep-pocketed parent.

Now, maybe the rating agencies will say that because Ambac can now write new municipal guarantee business, the holding company itself deserves a higher rating, like AA-/Aa3, and thus Connie Lee can get a AAA/Aaa.

2) Connie Lee has no track record of its own, and many on the management team that made the faulty decisions at Ambac, Inc. are still in place.  Yes, they managed their muni business well, but what if they go down the same diversification path again?  Regulators have short memories, and they do move on to other pursuits after some time.

It seems that Connie Lee will be a subsidiary of Ambac Assurance, so fraudulent conveyance issues are probably dead.  If Ambac Assurance were unable to pay all claims, Connie Lee could be sold, and the proceeds used to help pay claims.

It will be interesting to see what the rating agencies do with this.  It would be in their short-term profit interest to make Connie Lee AAA/Aaa, but they’ve been burned by Ambac before.  If they make Connie Lee AAA/Aaa, they should get complaints from others alleging unfair notching.  Also, to give them a AAA/Aaa would be to put the rating agencies own business models at risk if something more goes wrong at Ambac, and their new notching means they have to downgrade Connie Lee.

If I were in the shoes of the rating agencies, I would wait to see how the non-municipal guarantee business matures over the next two years, particularly given softness in the residential real estate markets.  Then, if Ambac Assurance began to look healthier, I would consider upgrading it and Connie Lee, one notch at a time.

PS — maybe larger municipalities will finally be weaned from needing insurance, and this market will amount to still less in the future…

Comments

[Philip on Top:]

Interesting, but the fact is that ABK would not have announced the transfer of personnel unless they have written guidance from the agencies on how to get AAA/Aaa rating for Connie.

This is a done deal.

2008 Sep 03 03:33 PM

[Ishortyou:]

yup, they are doing a good job in remediating their book of business, Bond insurers are going in the right direction a matter of time before they restablished themselves to pre-crash levels.

2008 Sep 03 03:45 PM

[Serge:]

I don't believe that track records and parent companies are relevant to ratings. In fact, I'm pretty certain that it's just the ability to pay claims.

2008 Sep 03 04:57 PM

[Tom Armistead:]

During the 2nd quarter conference call Callan addressed what he thought the concerns would be: "The fact that this company will be totally independent of Ambac, and that by its by-laws will restrict its business to the area of public finance, will certainly buttress the case for an AAA stable rating; at least we think so."

Apparently the 850 million in Connie Lee will be out of reach of Ambac and not exposed to any Structured Finance. The politics of the situation favors the triple A rating - state and local governments are staffed by politicians and they have an interest in low cost credit for municiplaities.

My only concern for Ambac is that if they get 850 million tied up in Connie Lee and can't write enough new business to generate a decent return the company will be a mediocre performer. Jay Brown (CEO of MBI) was careful to state that MBI won't go the triple A subsidiary route unless they are satisfied they can earn an acceptable rate of return.

2008 Sep 03 05:06 PM

[Ishortyou:]

Best for both companies to save all the cash possible and get rid off toxic waste to increase their capital/laibility ratio in their books.

2008 Sep 03 05:49 PM

[corellian98:]

Buffet's bond insurer got a AAA rating.....within days, even with the Moody's conflict of interest, so I am not too worried here. Do you even know what the requirements are for a AAA rating? I surely don't, but I am confident ABK has spent some time figuring it all out :)

Your comments seem weak at best.....and you lose credit when you say Connie Lee is small.

You also lose credit when you question indirectly the amount of bond insurance business there is out there to be had. Do you think Buffet got into the bond insurance business to be nice...no, he did it because there is a huge amount of business tobe had....and it is highly profitable.

SeekingAlpha should not allow bloggers to post without full disclosure. I am long ABK, ETFC, ESLR, CSUN, AKNS, FRE, ALU

2008 Sep 03 11:39 PM

[Encuero:]

Dude, you're a looser! ABK will get a Aa rating, until Ambac lands a large deal to prove to all that their still in business. Look, if you're view arn't positive, then short the stock and let us know is 6 months how you do, o.k!

2008 Sep 05 02:14 PM

[pahwah:]

The bailout of FNM and FRE provides the level of comfort that Mr. Market has been looking for. If you have been in cash or short, you need to cover and get long. This market has been looking for an excuse to rally and I believe we've found it. Technically, ABK appears ready to bust through the 200 DMA and then we will move $20 faster than people will believe. Let's see if I'm right.

2008 Sep 06 01:16 PM