Citing expectations for larger losses on mortgage-backed securities, Moody's Investors Service lowered its rating on Ambac Financial Group's Ambac Assurance bond insurance unit to junk territory.
The ratings agency late Monday downgraded financial strength ratings of Ambac Assurance and the company's U.K. arm by five notches to "Ba3" — three notches into junk — from "Baa1."
Moody's also cut the senior debt of Ambac Financial six notches further into junk, to "Caa1" from "Ba1." The outlook is developing.
"The downgrade of Ambac's ratings primarily reflects weakened risk adjusted capitalization, as Moody's loss estimates on RMBS securities have increased significantly (particularly with respect to Alt-A transactions)," the agency said.
Moody's added that its higher loss estimates boost the estimated capital required to support Ambac's residential mortgage-backed securities portfolio. Moody's noted that Ambac's current resources to pay out claims are higher than the agency's loss estimates, but said "this cushion has been significantly eroded," and that losses in more severe stress scenarios would wipeout available resources.
Ambac's qualified statutory capital, which includes policyholders' surplus and contingency reserves, totaled about $3.5 billion at the end of 2008.
Moody's said the insurer's reduced capitalization, weakened business position and very constrained financial flexibility limit Ambac's ability to effectively counter the company's decline in capital position.
For its part, Ambac noted that this downgrade marks Moody's tenth such opinion change since January 2008.
The company said it is "confident of the strength of the financial guarantee business model," and that it will "continue to execute a thoughtful, well-developed strategy" to maintain its role in the global capital and credit markets.
Like others in its industry, Ambac was hit hard in the past two years by losses on its coverage of risky financial instruments such as mortgage-backed securities and has been working to reduce its exposure to such debt instruments. Last month it reported a narrower fourth-quarter loss, though it still totaled $2.34 billion as the company cut the value of certain holdings, set aside more cash for potential losses and reduced its exposure to its riskiest insurance products.
Ambac has said it will launch a separate unit, called Everspan Financial Guarantee Corp., that would handle municipal bond insurance, keeping that part of the business insulated from the riskier operations that have caused the bulk of the losses. The company also said last week it has terminated all reinsurance transactions with RAM Reinsurance Co. in an effort to reduce counterparty risk.
