Bond Insurers’ Distress Rattles Wall Street

If it was a terrible week for Wall Street, it was a devastating one for companies that promise to protect investors against bond losses.

Already under siege for having branched into risky mortgage-related debt from far safer municipal bonds, two bond guarantors — who have insured hundreds of billions of dollars of debt — ended the week in severely weakened conditions.

One insurer, Ambac Assurance, which lost nearly three-fourths of its stock market value in the first four days of the week, lost one of its most coveted assets on Friday: the AAA credit rating that has allowed it to guarantee lower-rated bonds. The company has guaranteed $556 billion in bonds, and about $66.9 billion of the amount is issued by collateralized debt obligations that have come under scrutiny in recent months. Altogether, bond guarantors have written nearly $3.3 trillion in insurance.

A smaller bond guarantor, ACA Financial Guaranty, was facing a midnight deadline to restructure its insurance contracts with investment banks or face a bankruptcy filing.

Ambac, ACA and other bond guarantors are far from household names, but their troubles have sent ripples down Wall Street and Main Street. Bonds issued by states and governments that were insured by the companies have already lost value and the problems may raise the cost of new debt they raise. For investors and banks that have insured their portfolios with Ambac, its downgrade to AA, from AAA, by Fitch Ratings raises fresh questions about just what value the insurance holds, if any.

“The most damning effect is on the value of bond insurance itself,” said Joseph R. Mason, a professor of finance at Drexel University and the Wharton School, both in Philadelphia. “The big question that should be asked for issuers is: ‘Why should I buy bond insurance?’ ”

Ambac, which had won clean bills of health from ratings agencies a month ago, surprised Wall Street on Wednesday by writing down its insurance portfolio by $5.4 billion and ousting its chief executive, Robert J. Genader, after he and the board disagreed over whether the company should raise more capital.

While much of the write-down was the result of declining market value of its contracts, the company admitted that an estimated $1.1 billion represented credit losses on which, over time, it would have to pay claims, something that the credit ratings firms had not anticipated.

After initially saying it would raise capital to shore up its AAA ratings from Standard & Poor’s, Moody’s Investors Service and Fitch Ratings, Ambac reversed itself on Thursday after its stocks lost half their value and a big shareholder called on the company to give up on the AAA rating. A day later, Fitch lowered its rating and S.& P. put a “negative” outlook on the company. Analysts say a downgrade from Moody’s and S.& P. would now seem likely.

“They blew it and lost their window of opportunity to raise capital,” Rob Haines, an analyst at CreditSights, a research firm, said about Ambac.

A spokesman for Ambac declined to comment.

Shares of Ambac closed down 4 cents, to $6.20 on Friday; they fell more than 70 percent for the week, from $21.73.

Mr. Haines said the downgrade did not mean that Ambac was insolvent. While the company will not be able to write many of the insurance contracts it used to before, it can “plod along” by collecting premiums on its existing contracts and pay out claims as bond defaults occur. Fortunately for the company, it only makes payments on lost interest and principal on the debt it insures as it comes due, not all at once when a default occurs.

“Even though this is a big, big negative,” Mr. Haines said, “it doesn’t mean it’s going to go out of business, policyholders can’t pull contracts.”

Customers who have bought insurance protection from Ambac will have to decide whether they should write down the value of that guarantee or sell the underlying bonds. Investors that are required to only own AAA-rated debt may have to sell Ambac insured bonds that no longer have that top implied rating.

“Investment funds, pension funds just flat out refuse to hold anything that is not AAA,” Mr. Mason said.

The New York Insurance Department, which oversees Ambac and MBIA, the nation’s largest bond guarantor, has been holding daily meetings with the companies, according to a spokesman, David Neustadt.

“As a regulator we have to be a facilitator” of several solutions, including a possible bailout, Eric R. Dinallo, the state’s insurance superintendent, said at a news conference before the Fitch downgrade. “That’s our No. 1 goal.”

ACA, which only had a single-A credit rating that was cut to CCC last month, is in a tougher position. Its insurance contracts require it to post collateral when the value of its contracts, or credit default swaps, fall. The company would have to put up at least $1.7 billion, money the company does not have. The company has ceded significant control to the Maryland Insurance Administration, a state agency that regulates it.

Shares of ACA Capital were up 2 cents, to 48 cents, in over-the-counter trading.
Source : http://www.nytimes.com