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January 20, 2008

Fitch Finally Found My Blog and Cut Ambac's Rating, So what's next...
by Reggie Middleton

This is the part where you should expect me to say all hell breaks loose. For those who don't follow me regularly, this is my take on the monolines and Ambac. Now, let's check the headlines... From Bloomberg.com:

Ambac's Insurance Unit Cut to AA From AAA by Fitch Ratings

Ambac Financial Group Inc., the second-largest bond insurer, was stripped of its AAA credit rating by Fitch Ratings after the company abandoned plans to raise new equity...Ambac Assurance Corp. was lowered two levels to AA and may be reduced further, New York-based Fitch said yesterday in a statement. The downgrade "reflects the significant uncertainty with respect to the company's franchise, business model and strategic direction," Fitch said... Without its AAA rating, New York-based Ambac may be unable to write the top-ranked bond insurance that makes up 74 percent of its revenue. Ambac may quit the business or sell itself, said Robert Haines, an analyst at CreditSights Inc., a bond research firm in New York. The downgrade throws doubt on the ratings of $556 billion in municipal and structured finance debt guaranteed by Ambac.

"This makes Ambac insurance toxic," said Matt Fabian, senior analyst and managing director at Municipal Market Advisors in Westport, Connecticut. And therein lies the fundamental problem. The insurance was toxic from the get-go. The Fitch change in moniker status did nothing to change this, but give us bloggers and some reporters something to type about. "The market has no tolerance for a ratings-deprived insurer."

Moody's Investors Service and Standard & Poor's, the two largest ratings companies, are reviewing Ambac's ratings for a possible reduction. Moody's said this week that it may also cut the ratings of MBIA Inc., the largest bond insurer. This all a big fat joke. They cut ratings after a 80% drop in price and announcement of a $33 per share loss? Don't do us any more favors. Like I have disclaimed earlier, I am far from a fixed income expert, but I could have sworn that the ratings agencies advisory was aimed at being predictive, and not reactive. All they are doing is telling people how much money they lost!!!

"The likelihood is quite high the others will follow," said John Tierney, credit market strategist at Deutsche Bank AG in New York. "Barring some significant development on new capital, it's just a matter of time before S&P and Moody's act on MBIA and Ambac."... The seven AAA rated bond insurers place their stamp on $2.4 trillion of debt. Losing those rankings may cost borrowers and investors as much as $200 billion, according to data compiled by Bloomberg. The industry guaranteed $100 billion of collateralized debt obligations linked to subprime mortgages, $22 billion of non-prime auto loans and $1.2 trillion of municipal debt. Buffet's stock may see a lot of demand out of this...

New York-based Merrill Lynch & Co., the world's largest brokerage, this week took $3.1 billion of writedowns on the value of default protection from bond insurers... Fitch, following its downgrade of Ambac Assurance, adjusted ratings accordingly for 137,990 municipal bonds and 114 non- municipal issues insured by the company. Bonds with underlying ratings higher than Ambac's will remain above the bond insurer's level, Fitch said yesterday in a statement...Fitch last month demanded the company raise $1 billion by the end of January. Ambac on Jan. 16 slashed its dividend 67 percent and said it would sell stock or convertible notes to bolster its capital. The plan provoked a boardroom dispute and led to the departure of Chief Executive Officer Robert Genader.

Ambac's interim CEO, Michael Callen, 67, said this week that the company planned to raise capital in "an accelerated time frame." And exactly how are they going to accomplish that.

Moody's said this week that it may cut Ambac's ratings after the company forecast writedowns of $3.5 billion on subprime-mortgage securities. S&P said yesterday that it may cut Ambac's rating because its capital-raising options are "impaired." I hate to say I told you so, but... The issue is now your credibility is severely damaged by making so many wrong calls to begin with, then taking so long to do something about them.

The sudden increase in scrutiny by Moody's, a month after the company affirmed the ratings, sparked tension with Ambac and MBIA. Ambac this week described Moody's decision to place its ratings on review as "surprising." MBIA issued a statement yesterday, saying it had started a capital raising plan "in good faith reliance" on Moody's stated requirements. You guys know you weren't a AAA risk. Let's stop the shenanigans, please...

MBIA's surplus notes plunged as low as 70 cents on the dollar yesterday, indicating a yield of about 25 percent, traders said. MBIA fell 67 cents, or 7.3 percent, to $8.55 on the New York Stock Exchange, taking its decline to 48 percent this week. Now, here I am going to say "I told you so"! Actually, my words were, "wait until they start trading!". I don't know what investors were thinking went they bought these notes! Do they not have professional advisors ? If not, I will offer free access to my blog for those that need it. A quick lesson for free - stop trying to reach for above market yields, for you may be handed above market losses in return.

Ratings companies, which affirmed their assessments a month ago, are scrutinizing bond insurers to ensure they have enough capital to protect against losses. S&P this week said industry losses on subprime securities will be 20 percent more than it initially forecast. Ambac has a capital shortfall of about $400 million under the new assumptions, S&P said. Well, one of us needs to recharge the batteries in our calculators, recalibrate Excel, or something. I see billions of dollars in shortfalls... (see Monolines swoon, CDO's go boom & I really wonder why the ratings agencies are given any credibility!)

Ambac's 6.15 percent bonds due in 2037 have plunged by 25 cents on the dollar this week to 35.4 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The yield has soared to 17.6 percent from 10.5 percent and the extra yield investors demand over government securities with similar maturities has widened 7.2 percentage points to 13.4 percentage points. And Moody's considers this a AA risk!!! Can you imagine what they would mean by the term JUNK!

Prices for credit-default swaps that pay investors if MBIA can't meet its debt obligations imply a 71 percent chance it will default in the next five years, according to a JPMorgan Chase & Co. valuation model. Contacts on Ambac imply 72 percent odds. Hey, isn't that what I said in the links above???

Contracts tied to MBIA's bonds have risen 10 percentage points the past two days to 26 percent upfront and 5 percent a year, according to CMA Datavision in New York. That means it would cost $2.6 million initially and $500,000 a year to protect $10 million in MBIA bonds from default for five years.... Credit-default swaps on Ambac, the second-biggest insurer, rose 11.5 percentage points to 26.5 percent upfront and 5 percent a year yesterday, prices from CMA Datavision show.

Ambac agreed to guarantee almost $200 million of bonds sold so far this year, or 6 percent of the market for new insured issues, according to data compiled by Bloomberg. Ambac's market share was 22.5 percent as of Sept. 30, 2007, according to a Dec. 13 report from Bear Stearns Cos. In a few days I will illustrate the relationship between Bear Stearns, Ambac, and Mr. & Mrs. CounteryParty Risk.

So, after all of this, what comes next??? Is this the part where you expect me to say, "All hell breaks loose!". Well, not all hell, but I think some companies may find just a taste of it...

Below is output from the Ambac mini-app, made available from one of my previous postings. I have sorted and categorized the issuers by alphabetical order and identified insured par and investment grade. I stripped the AAA products out of this pivot table, although we all know what that moniker is worth these days. Despite that, Fitch says that they will not harass the AAA guys. Anyway, let's see who's on the "I shouldn't have dealt with Ambac!" list.

In the chart below, bonds whose rating are AA and who are not on negative watch will not be affected by this downgrade.

This was definitely no suprise. I have been screaming about the monoliners for some time now. Last month I ran a series, Bank, Brokers and Bullsh1+ (see part one for model risk, and part two for counterparty risk) which discussed model risk and counteryparty risk. How timely. All of the research that I posted will be effected by these events, significantly. Look to see updates and adverse price movements in the homebuilders (banks can no longer afford to be lenient), investment banks (big you haven' t really seen a write down yet), commercial real estate (those refi's are really going to get scarce now), and of course the monolines.

I have written much more juicy stuff on monolines with plenty of analytics, cartoons and jokes. A little something for everybody:

1. A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton
2. Tie-in to the Halloween Story
3. Welcome to the World of Dr. FrankenFinance!
4. Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion
5. Follow up to the Ambac Analysis
6. Monolines swoon, CDOs go boom & I really wonder why the ratings agencies are given any credibility
7. More tidbits on the monolines
8. What do Brittany Spears, Snow White and MBIA have in Common?
9. Moody's Affirms Ratings of Ambac and MBIA & Loses any Credibility They May Have Had Left
10. My Analyst's Comments on MBIA/Ambac/Moody's Post
11. As was warned in this blog, the S&P downgrade of a monoline insurer reverberated losses through c

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

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