AMBAC’S ‘AAA’ RATING AFFIRMED
AMID 11TH HOUR DEAL

Standard & Poor’s reaffirmed Ambac Financial Group, Inc.’s “AAA” rating, though the insurer remained on CreditWatch with negative implications as capitalization plans were being worked out.

Ambac was reported in discussions with several of the nation’s largest banks to provide a $3 billion recapitalization of the insurer, of which $2.5 billion would be equity, and $500 million would be raised through issuance of new debt.

The agreement was designed to stave off an impending downgrade by S&P and Moody’s. The rating agencies had recently placed Ambac and other bond insurers on Negative Watch following announcements of major write-downs and credit impairment losses on CDO mortgage obligations. Ambac expects a $5.4 billion mark-to-market paper loss on its exposure for the calendar year ended December 31, 2007, and an actual loss of $1.1 billion on such transactions.

S&P said it affirmed the insurer’s “AAA” rating based on Ambac’s capital-raising plans, and kept it on CreditWatch with negative implications “to reflect uncertainty surrounding the risk profile and capitalization plans for the reported new corporate structure being contemplated by the holding company.

In addition to Ambac’s recapitalization plan, other terms are believed to include the division of Ambac into two new companies, one insuring traditional municipal debt, the other retaining Ambac’s exposure to structured finance guarantees including CDOs and other derivative securities. Ambac could use its Connie Lee subsidiary as the municipal bond insurance vehicle, leaving the parent, Ambac, with the structured finance business.

Acceptance of such a plan would be problematic for some market participants. Questions have been raised as to whether all current Ambac investors would be treated equally under this proposal. Others see this approach as having little benefit for the banks involved. They fear the banks are heading for “double trouble” by propping up a bond insurer to whom those same banks have significant exposure through their CDO portfolios. Finally, some market observers question whether the $3 billion bailout would only be the first step, since Ambac’s eventual impairment could well exceed that amount. There is also concern that a dilution of Ambac’s common stock could lead to shareholder lawsuits.

Other bond insurers will also be watching any Ambac deal closely. If successful, they, too, are likely to attempt similar deals, under the watchful eye of New York State Insurance Commissioner Eric Dinallo. 

S&P and Moody’s, knowing full well that their stamp of approval on the Ambac plan will set a precedent, need to carefully consider the consequences.  . 

The last thing the bond raters need for their already tarnished reputations is to approve a bailout that turns out to be a half-way measure.

02/25/08