I went through your blog and the new post on Moody's rating affirmation and Ambac's reinsurance was fairly comprehensive. I especially liked the part where you talked about blood transfusion between two sick people and calling it a cure. I can't think of a better analogy that fits so well in this case.
Regarding my opinion on your post, From what I could gather, Ambac, struggling to avoid the losses of its AAA credit rating, took out insurance on $29 billion in securities it guarantees. The world's 2nd largest bond insurer agreed to transfer the risk that the securities will default to Assured Guaranty Ltd.
Robert Genader, Ambac's CEO had the following comment:
"Reinsurance is a valuable, capital-efficient and shareholder-friendly tool or managing risk and capital."
Reinsurance on $29 billion out of $556 billion portfolio – don’t know how much “risk” the company is likely to manage by reinsuring 5% of its portfolio. And, this reinsurance is certainly is not shareholder friendly as the management would like us to believe. It basically dilutes future earnings attributable to the shareholders. More importantly, the management has not commented upon the amount of capital they freed through this deal. Another point that needs attention is Assured Guaranty will not insure any CDOs (read: toxic waste). Taking a closer look at this deal in the overall context of Ambac’s portfolio, Ambac insures $8.8 billion of securities backed by subprime mortgages and $29.2 billion of collateralized debt obligations that repackage pools of subprime mortgage debt and slice them into new pieces with varying degrees of risk. My view is that all Ambac could manage through this deal was to sell the “potentially good” assets for an undisclosed amount while retaining the “potentially bad” ones. (Although I presume the reinsurance deal was favorable to Assured Guaranty).
Another caveat here is the credibility of the reinsurer. Fitch recently
affirmed Assured Guaranty's AAA insurance and reinsurance ratings after the company announced a plan to raise $345 million through share sales and give
the proceeds to Assured Guaranty Re Ltd. so it can reinsure more deals. However, MBIA (which apparently is in a negative rating watch list) holds 17% stake in the reinsurer!!!
And, according to Moody’s, Ambac's AAA rating was affirmed because the insurer has “enough” capital. That was even before the company had announced that it was buying reinsurance from Assured Guaranty.
Again, should these companies be having AAA ratings?
Security Capital Assurance Ltd. (SCA) insures $154.2 billion of securities, of which 46% is structured finance securities, including $16.1 billion of CDOs backed by subprime mortgages and $1.9 billion of subprime mortgage
backed bonds. According to Fitch, SCA is now more than $2 billion short of
the capital it needs to maintain the AAA rating. SCA is only the fifth largest bond insurer — if it needs to raise $2 billion, how much more will the largest players, MBIA and Ambac, have to raise? We have mentioned this
in Ambac as well as MBIA valuation spreadsheets that they’ll need to raise
at least $3-4 billion each in the base case scenario. Can they raise such huge amounts in this environment? MBIA’s market cap is $3.8 billion and that of Ambac is $2.5 billion.
I’m not too sure if this is the parameter (or one of the parameters) for assigning AAA rating, but it should be!!!
And then MBIA announced last Thursday that they’re canceling Friday's conference call, due to pending rating agency “reviews”. Wonder if they have something to hide!!! Do they have clauses in the deal with Warburg which says that the additional funding of $500 million would be subjected to MBIA maintaining its AAA rating? I don’t know as yet. Perhaps I would be in a position to comment on that once they disclose the deal’s details in the filings.
Meanwhile, I came across something really interesting on Fitch’s rating
model . In a conference call regarding securitization and the sub-prime mortgage market crisis, Fitch responded to First Pacific Advisors like this:
Q: What are the key drivers of your rating model?
Fitch: FICO scores and home price appreciation (HPA) of low single digit
(LSD) or mid single digit (MSD), as HPA has been for the past 50 years.
Q: What if HPA was flat for an extended period of time?
Fitch: They responded that their model would start to break down.
Q: What if HPA were to decline 1% to 2% for an extended period of time?
Fitch: They responded that their models would break down completely.
Q: With 2% depreciation, how far up the rating’s scale would it harm?
Fitch: They responded that it might go as high as the AA or AAA tranches.
So now, when these rating agencies talk about rating in “base” and “stressed” conditions, I’m not sure of what they really mean.