Moody's comments on continuing review of Ambac
New York, February 29, 2008 -- Moody's Investors Service announced today that it has concluded
its analysis of the residential mortgage and mortgage-related CDO
exposures of Ambac Assurance Corporation, and is continuing a review
for possible downgrade that was initiated on January 16, 2008.
Based on an updated assessment of Ambac's mortgage risk, Moody's
believes that Ambac's capital exceeds the minimum Aaa standard but
falls below the Aaa target level. As outlined in Moody's
previous communications with the market about such situations, it
is our practice to evaluate plans the company is pursuing to close the
gap between actual capitalization and target levels, including the
certainty of those plans and the timeframe over which they would likely
be realized. Ambac is actively pursuing capital strengthening activities
that, if successful, are expected to result in the company
meeting Moody's current estimate of the Aaa target level.
Moody's continuing review will focus on both the further refinement
of, and execution of, those capital plans, as well as
on substantive changes that Ambac is implementing to its risk and operating
strategies going forward.
OVERVIEW OF RATING APPROACH
As outlined in Moody's Rating Methodology for Financial Guarantors,
we have evaluated Ambac along five key rating factors: 1) franchise
value and strategy, 2) insurance portfolio characteristics,
3) capital adequacy, 4) profitability, and 5) financial flexibility.
Of these factors, capital adequacy is given particular emphasis.
To estimate capital adequacy, Moody's has applied its traditional
portfolio risk model for determining stress losses on the non-mortgage
related portion of Ambac's insured portfolio, and alternative
stress tests for the mortgage and mortgage-related CDO exposure.
For mortgage-related exposures, stress losses were estimated
using assumptions consistent with a scenario where 2006 subprime first-lien
mortgages realize an average of 21% cumulative pool losses,
with other vintages and products stressed accordingly. Stress-level
losses for RMBS transactions were assessed on a transaction-by-transaction
basis, while loss estimates for ABS CDOs were derived using a stochastic
simulation model which applied stress to specific underlying collateral
tranches within the CDOs. Estimated tranche-level losses
were computed based on the structure of those tranches (e.g.,
attachment and detachment points) and estimates of their performance relative
to the average.
Losses estimated under the approach described above were present-valued
to reflect estimates of the payout pattern that would emerge, based
on the collateral type. For ABS CDOs, consideration was given
to specific contractual features within associated CDS contracts.
These factors resulted in aggregate present value discounts to principal
loss estimates of approximately 8% for RMBS and 22% for
ABS CDOs. Non-mortgage risks are discounted within the portfolio
model based on estimates of payout patterns as well.
In view of the expected correlation between the prospective experience
of Ambac and its reinsurers, and given reviews for possible downgrade
of RAM Reinsurance Company Ltd. (Aa3) and BluePoint Re Limited
(Aa3), Moody's has also, for purposes of estimating
capital adequacy, reduced the estimated credit given for reinsurance
in the stress case, to 73%, on average, across
In comparing estimated stress losses to claims paying resources and associated
rating levels, Moody's combines an estimated loss distribution
for mortgage risks with one for non-mortgage risks, assuming
a correlation between the two that ranges from 90% (for Aaa) down
to 30% (for Baa3). Claims paying resources are then compared
to the indicated capital need, at the target benchmark (1.3x
KEY RATING FACTORS -- CAPITAL ADEQUACY
Based on the risks in Ambac's portfolio, as assessed by Moody's
according to the approach outlined above, estimated stress-case
losses would approximate $12.1 billion. This compares
to Moody's estimate of Ambac's claims paying resources of approximately
$13.7 billion, resulting in a total capital ratio
of 1.13x, which exceeds the "minimum" Aaa level,
but is short of the 1.3x Aaa "target" level by about
$2 billion. Moody's further noted that in the most likely
or "expected" scenario, Ambac's insured portfolio
will incur lifetime losses of approximately $4.2 billion
in present value terms, and that Ambac's current claims-paying
resources cover this expected loss estimate by about 3.2x.
KEY RATING FACTORS -- BUSINESS AND FINANCIAL PROFILE
In Moody's opinion, Ambac's significant exposure to
mortgage-related risk has had consequences for its business and
financial profile beyond the associated impact on capitalization,
and affects our opinion about Ambac's other key rating factors.
Nonetheless, despite some of the recent challenges faced by the
company related to investor confidence, Moody's believes that
Ambac is better-positioned relative to certain less-established
competitors with respect to business franchise, prospective profitability
and financial flexibility.
With respect to underwriting and risk management, Moody's
believes that Ambac's significant exposure to the mortgage sector
is indicative of a risk posture greater than would be consistent with
a Aaa rating going forward. The company's participation in
several 2007 vintage CDO-squared transactions, in particular,
contributed to this view. Moody's expects Ambac to implement
significant changes to its underwriting and risk management guidelines
to reduce volatility in its insured portfolio, including the exit
from certain types of structured finance business, as well as tighter
risk controls around the structured finance business the company intends
to pursue going forward. In Moody's opinion, it will
be critical for the company to focus on reducing single risk concentrations
across its portfolio. Moody's also believes that Ambac's
non-core asset management activities, including GICs and
interest rate and total return swaps, place incremental negative
pressure on its ratings.
Prospectively, Ambac's profitability is likely to remain below
historical levels over the near to intermediate term, particularly
given the reduced issuance volumes generally, and investor caution
about financial guarantors with mortgage-related exposures.
It is uncertain how long this situation will persist. However,
some earnings stability is provided by Ambac's large in-force
portfolio, which will continue to provide significant premium revenue
even if new business production remains sluggish over the near term.
The ability of the company to reestablish its strong market position in
the US public finance market will take time. In Moody's opinion,
however, Ambac's extensive relationships with issuers,
as well as its prominent market position, expertise and execution
capabilities in several market sectors, provide the company with
a good foundation from which to regain market confidence in the US public
In terms of financial flexibility, Ambac, like other financial
guarantors, benefits from its ability to pay claims over an extended
period of time, typically scheduled interest and principal at maturity.
Moody's has also considered in its rating review the potential for
calls on liquidity at Ambac in the context of available resources,
including the investment profile of the operating insurance entities and
its asset management activities. Ambac's financial leverage
profile could increase if incurred losses further erode shareholders'
equity. Additional debt in the capital structure would increase
leverage and place additional demands on the operating companies to service
fixed charges. Here, Moody's believes that holding
company liquidity is currently adequate, supported by dividend capacity
from Ambac Assurance Corporation and additional debt service coverage
available through cash and investments held at the holding company.
VIEW ON POSSIBLE SPLIT OF MUNICIPAL AND STRUCTURED BUSINESSES
Ambac could elect to pursue public finance and structured finance businesses
through distinct legal entities. The ratings appropriate for separate
insurers operating under such a strategy would depend on their specific
business and financial characteristics, including capitalization
and underwriting frameworks. In this scenario, Moody's believes
that the structured finance guarantor would be more challenged than its
public finance affiliate to maintain a Aaa rating, due to the relatively
greater complexity of risks and higher risk concentrations evident in
that sector of the market. Those risks are more muted within a
single-company structure where more granular and lower-risk
public finance exposures provide diversification across risk and time
dimensions. Moody's further believes that guarantors splitting
their business among distinct legal entities might have a greater incentive
to allocate capital in favor of the public sector guarantor, given
the somewhat greater importance attached to Aaa ratings by customers in
that market. The effect of these structural changes would likely
be to reduce the risk of downgrade for the guarantor's insured municipal
debt and to increase the risk of downgrade for the insurer's other exposures.
OVERVIEW OF AMBAC
Ambac Financial Group, Inc. (NYSE: ABK), headquartered
in New York City, is a holding company whose affiliates provide
financial guarantees and financial services to clients in both the public
and private sectors around the world. For the year ended December
31, 2007, Ambac reported a net loss of approximately $3.3
billion. As of December 31, 2007, Ambac had shareholders'
equity of approximately $2.3 billion.
Financial Institutions Group
Moody's Investors Service
Vice President - Senior Analyst
Financial Institutions Group
Moody's Investors Service