Another Ambac Downgrade By Moody's

Ambac said then that it was establishing an Ambac Assurance subsidiary–Everspan Financial Guarantee–as a municipal-only financial guarantor, to begin doing business during the second quarter.

Yesterday, in reaction to Moody's latest move, the insurer noted that this was the tenth rating firm change in the past 15 months, and in the interval, "Ambac has been actively refining its risk management and remediation capabilities, preparing to launch a well-capitalized, municipal-only financial guarantee subsidiary and developing business opportunities that capitalize on the current market dislocation."

Ambac said it is "confident of the strength of the financial guarantee business model, which is founded on aggressive risk mitigation, organic risk delevering and claim payment obligations that reflect scheduled principal and interest over the lives of the transactions."

The current outlook for the Ambac ratings is developing, Moody's said, explaining that the downgrade reflects weakened risk-adjusted capitalization, as Moody's loss estimates have risen.

Loss projections on residential mortgage-backed securities (RMBS) have increased significantly, meaning additional capital is required to support Ambac's sizable direct RMBS portfolio–including asset-backed securities and collateralized debt obligations, according to Moody's.

Claims-paying resources of Ambac remain above Moody's expected loss estimates for the firm, although this cushion has been significantly eroded, and losses in more severe stress scenarios would exceed available resources, the firm noted.

Ambac recorded a statutory net loss of $4 billion for 2008, ending the year with $1.6 billion in policyholders' surplus only after giving effect to $2 billion of new capital raised during the year.

Qualified statutory capital–comprised of policyholders' surplus and contingency reserves–stood at approximately $3.5 billion at year-end 2008, but remains vulnerable to increases in case loss reserves over the near to medium term, based on Moody's expected loss estimates.

The firm found Ambac's current impairment provisions for collateralized debt obligations are highly sensitive to estimates of future cash flows on underlying CDO collateral and projections of the timing of claims payments many years into the future.

Moody's said Ambac's liquidity risks associated with its investment agreement business have been largely contained due to inter-company asset purchases and lending, with approximately 93 percent of investment agreement liabilities collateralized.

Ambac Assurance's investment portfolio credit profile has deteriorated due to the purchase of structured finance assets from the financial services business, according to Moody's.

The firm reported that at year-end 2008, the market value of Ambac's consolidated invested assets was approximately $2.5 billion below amortized cost, with much of the difference attributable to RMBS assets.

Moody's said it believes large liquidity premiums contribute to this differential, and it also expects some further loss to principal based on Moody's ratings on these securities.

Ambac, it was noted, is steadily de-leveraging through natural portfolio run-off, high levels of refundings and via commutations of credit default swaps on asset-backed CDOs.

However, Moody's found that downward credit migration in the firm's insured portfolio outside its mortgage-related exposures has largely offset the positive capital accretion benefits associated with the de-leveraging process to date.

Moody's said Ambac has a "weakened business position and very constrained financial flexibility." Taken together, Moody's said it believes that these factors limit Ambac's ability to effectively counter the company's weakened capital position.

Moody's stated that Ambac's developing outlook reflects the potential for further deterioration in its insured portfolio as asset performance develops over the intermediate six-to-18-month term.

It also incorporates positive developments that could occur over that time, including lower variability in mortgage-related asset performance, the possibility of commutations or terminations of certain CDO exposures, and/or successful remediation efforts on poorly performing RMBS transactions.

The company's developing outlook, according to Moody's, is also based on the potential for various initiatives being pursued at the U.S. federal level to mitigate the rising trend of mortgage loan defaults.

Moody's said it will continue to evaluate Ambac's ratings in the context of the future performance of its insured portfolio relative to expectations and resulting capital adequacy levels, as well as changes, if any, to the company's strategic and capital management plans.