Capital Markets

Ambac Jabs with Moody’s over Debt Downgrade

The insurer's view of its financial health diverges widely from the ratings agency's assessment.
Stephen TaubNovember 7, 2008

Ambac Financial is engaged in a sparring match with Moody’s Investors Service over its financial strength, and equity investors are caught in the middle.

The fracas broke out on Wednesday when the rating agency downgraded the bond insurer’s senior unsecured debt four notches to junk status, to Ba1 from A3. Moody’s also downgraded from Aa3 to Baa1 — still investment grade — the insurance financial strength rating of Ambac Assurance Corp. and Ambac Assurance UK Ltd. following the release of third-quarter results.

The agency explained that the downgrades reflect its view of Ambac’s “diminished business and financial profile” resulting from its exposure to losses from U.S. mortgage risks and disruption in the broader financial guaranty business.

Moody’s elaborated that the downgrade results from four factors. First is its expectation of greater losses on mortgage-related exposure, noting that the company’s reported losses and related increases in loss reserves in the third quarter were broadly consistent with Moody’s current expectations. The rating agency also cited the possibility of even-greater-than-expected losses in extreme stress scenarios, the company’s diminished business prospects, and its impaired financial flexibility.

The moves were made after Ambac said in its third-quarter report that it had incurred losses of $608 million on financial guaranty policies, primarily related to direct residential mortgage-backed securities exposures, and $2.5 billion of credit-related impairments on credit-default swaps.

Moody’s did note that Ambac’s insurance financial strength rating remains investment grade, reflecting the rating agency’s view that Ambac’s aggregate resources (including statutory contingency reserves and contingent capital) provide a meaningful capital cushion above expected loss levels. “Should Ambac’s regulatory capital position continue to deteriorate, there would be further negative pressure on the firm’s ratings,” it added.

In response to the downgrades, Ambac president and CEO David Wallis asserted in a press release: “It is disappointing that Moody’s has come to a ratings conclusion without the benefit of completing its own analysis of our portfolio.”

Ambac noted that Moody’s itself stated that Ambac’s reported losses are broadly in line with its own expectations, and that Moody’s acknowledged Ambac has a meaningful capital cushion above expected loss levels.

The insurer also stressed that Moody’s noted various factors that could have an impact on Ambac’s rating in the near to medium term, including remediation and commutation activity and the beneficial impact of TARP and other initiatives. “Ambac believes that these factors will have a material and positive effect and that the timing and extent of this rating action is unfortunate,” it added.

Ambac’s equity investors, meanwhile, have been whipsawed by these events. The company’s shares dropped 20 percent on Wednesday and 24 percent on Thursday; at midday Friday, however, they were up 16 percent to $1.76.