Wednesday, December 19, 2007

Ambac, MBIA Outlook Lowered by S&P, ACA Cut to CCC (Update5)

By Christine Richard

Dec. 19 (Bloomberg) -- The ratings outlook for MBIA Inc. and Ambac Financial Group Inc., the world's largest bond insurers, was lowered to negative by Standard & Poor's, raising the specter of more writedowns for the companies' investment-bank clients.

S&P also cut its A rating on ACA Financial Guaranty Corp. to CCC, suggesting potential default. Toronto-based Canadian Imperial Bank of Commerce said today it may have $2 billion of writedowns on U.S. subprime mortgage securities it insured through ACA.

``The hits keep coming,'' said Gregory Peters, head of credit strategy at Morgan Stanley in New York. ``It's been our view that these guys are in a much more difficult predicament than investors or the companies themselves believed.''

Industrywide downgrades would lead to losses of $200 billion on securities as some banks would have to sell their bonds in a depressed market because of investment guidelines, according to data compiled by Bloomberg. MBIA's guaranty business stands behind about $652 billion of municipal and structured finance bonds, while Ambac's insures $546 billion of debt. Both are rated AAA.

S&P also reduced its outlook to negative from stable for XL Capital Assurance Inc. and placed Financial Guaranty Insurance Co.'s AAA rating under review for a possible downgrade. The actions were ``prompted by worsening expectations'' for insured nonprime residential mortgage bonds and collateralized debt obligations of asset-backed securities, New York-based S&P said.

Ambac rose 48 cents to $27.46 at the close of regular New York Stock exchange trading. MBIA dropped 68 cents to $27.02. The companies have lost more than half their market value this year.

`Everyone Got Greedy'

The changes by S&P follow negative actions on Armonk, New York-based MBIA's guaranty business and CIFG Guaranty by Moody's Investors Service last week. Bond insurers are paying a price for expanding beyond their traditional business of backing municipal bonds to guaranteeing debt linked to riskier subprime mortgages and home-equity loans, as well as CDOs.

``Everyone got greedy and thought they were smart enough to write structured product insurance like it was the same as insuring municipal bonds,'' said Rob Haines, an analyst with CreditSights Inc. in New York.

S&P ran a stress test to determine the losses bond insurers would take on securities backed by subprime mortgages, including CDOs. Losses were projected at $3.1 billion for MBIA, $1.8 billion for Ambac, and $2.2 billion for FGIC.

MBIA's higher loss potential was attributed to the company's guarantees on securities backed by home equity loans, S&P said.

CIBC, Merrill

The ratings cut on ACA Financial, a unit of ACA Capital Holdings Inc., may lead to writedowns at Merrill Lynch & Co. and Canadian Imperial Bank of Commerce. Toronto-based CIBC said today it will likely take a large writedown because New York-based ACA insures about $3.5 billion of its U.S. subprime investments.

Merrill Lynch may have used contracts with ACA Capital to pass off the market risk of $5 billion in CDOs, Roger Freeman, an analyst covering the brokerage industry for Lehman Brothers Holdings Inc., wrote in a Nov. 5 report. If ACA Capital defaults on its swap contracts, Merrill Lynch could recognize unrealized losses on those securities of about $3 billion, Freeman wrote.

ACA Capital is required to post $1.7 billion in collateral if its rating falls at least two steps to below A-, management said on a Nov. 8 conference call. The rating was cut 12 levels today to CCC from A. The company said Nov. 19 it wouldn't be able to post that much or make termination payments on the contracts.

ACA Capital Bailout

Bear Stearns Cos. and Merrill Lynch are among several major banks in talks to bail out ACA, the New York Times reported today, citing two people familiar with the situation.

``Effectively by bailing out the monolines, they're bailing out themselves, because the hedges they thought they had with them aren't really hedges,'' said Toby Nangle, who helps oversee $37 billion as head of global aggregate business at Baring Asset Management in London.

ACA Capital rose 34 cents to 65 cents in over-the-counter trading on that news. The shares, suspended by the New York Stock Exchange this week for breaching capitalization requirements, had plunged 98 percent this year.

ACA Capital as of June 30 had sold protection to 31 counterparties through credit-default swaps on $61 billion of highly rated securities, including CDOs backed by subprime mortgage securities, according to filings. CDOs are created by packaging debt or derivatives into new bonds with varying ratings.

Losses Grow

The collapse of the U.S. subprime mortgage market has led to about $76 billion of losses at securities firms and banks this year. Subprime loans are made to people with poor credit.

Ambac, the second-biggest bond insurer, guarantees $546 billion of securities. MBIA stands behind about $652 billion of municipal and structured finance bonds, while FGIC Corp., parent of Financial Guaranty Insurance Co., insured $314 billion.

``We are confident the performance of our insured portfolio and the measures being taken to expand Ambac's capital position will be sufficient to return our outlook to stable,'' Ambac Chief Executive Officer Robert J. Genader said in a statement today.

For more than 20 years, the safety of bond insurance has eased the way for elementary schools, Wall Street banks and thousands of municipalities to sell debt with unquestioned credit quality. The bond insurers promise to make interest and principal payments as they come due on securities if the issuer falters.

``If these companies are going to survive, they've got to go back and focus on the core muni business,'' Haines said.

Moody's, Fitch and S&P, criticized throughout the credit slump for giving excessively high ratings to asset-backed debt, took a second look at the bond insurers in the past few weeks after sweeping downgrades of CDOs. The companies had issued reports as recently as October that said the insurers were unlikely to face capital constraints because of the subprime mortgage crisis.

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