Bond insurance suffers big stock drop

By Dan Seymour

Published: January 18, 2008

NEW YORK — Bond insurance stocks plunged Thursday after a ratings agency said Ambac Financial Group Inc.'s plan to raise cash may not be enough to save its crucial credit rating.

Ambac fell 51.9 percent to $6.24, while chief rival MBIA Inc. fell 31.2 percent to $9.22. Smaller competitors Security Capital Assurance and ACA Capital Holdings also fell substantially. The sector's woes helped drag the broader market sharply lower, as well, with the S&P 500 closing nearly 3 percent lower.

Moody's Investors Service said Wednesday night it is considering cutting Ambac's "AAA” financial-strength rating, which would squelch the insurer's prospects for winning new business.

The ratings agency issued the report after the New York-based bond insurer cut its dividend by two-thirds, said a portfolio of insurance contracts had lost $5.4 billion in value, replaced its chief executive and unveiled a plan to sell $1 billion in stock to fortify its cash reserves.

"A rating agency downgrade would be the death knell for Ambac,” Friedman Billings Ramsey analyst Steve Stelmach wrote in a client note. "Merely the threat of a downgrade complicates the company's capital-raising plans even further.”

Ambac and MBIA are under pressure to prove their capital cushions are sufficient to cover claims. For the last decade, Wall Street firms bundled and sold pools of mortgages, auto loans, credit card bills and other debt to investors. The riskiness of these securities was thought to be offset by the promise insurers would step in to make principal and interest payments if issuers defaulted.

Because default rates have been low, bond insurers' earnings and share prices had soared — until recently.

The prospect of ratings downgrades has devastated the sector in the past six months. Some stocks have plummeted 85 percent or more as investors worry about more claims from defaulted bonds and the degree to which a ratings downgrade would damage new business prospects.

The loss on Ambac's insurance contracts "significantly reduces the company's capital cushion and heightens concern about potential further volatility” in the company's portfolio of mortgage debt insurance, Moody's credit analyst James Eck said in a statement.

Fitch Ratings has given Ambac roughly until the end of the month to raise $1 billion or face a downgrade, and Standard & Poor's this week relaunched a review of bond insurers' ratings in light of assumptions for more losses on bad mortgage loans.

S&P expects losses for the bond insurance industry to be 20 percent higher than the ratings agency thought, which could apply further pressure on Ambac and MBIA. That forecast stems from S&P's assumption that losses on bad mortgage loans issued in 2005 and 2006 will be higher than expected.

Ambac insured about $555 billion in debt at the end of September. MBIA insures more than $670 billion.

Stelmach said Ambac will have trouble finding lenders as long as the threat of a downgrade hangs over the company. According to a report Thursday, the $1 billion in bonds MBIA just sold to stave off a downgrade already trade at a substantial discount.

Stelmach has cut his price target on Ambac's stock to $10 from $30 in the past two days. Earlier Thursday, the stock traded as low as $4.50, its cheapest trade in its 16-year history. MBIA shares also set a new low.

Evercore Asset Management LLC, an investment adviser whose clients own 700,000 shares of Ambac, wrote a letter to the company's board Thursday opposing selling stock to try to maintain the "AAA” financial-strength rating.

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