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Moody's on Wednesday cut Ambac Assurance Corp's rating four notches to "Baa1," the third-lowest investment grade, from "Aa3," following the company's third quarter loss.
The downgrade required Ambac to post additional collateral against some of its contracts, which created a $2.3 billion cash shortfall at its financial services unit, according to JPMorgan.
This was only resolved after the Wisconsin insurance regulator allowed Ambac to transfer funds from its insurance unit to the financial services unit to cover the collateral needs.
"The future of Ambac remains an open question," JPMorgan analyst Eric Beinstein said in a report on Friday.
"We believe that access to TARP money is an urgently relevant question for the survival of the company," he added. "The risk of an Ambac credit event has thus significantly increased."
Since June, when Ambac was stripped of its "AAA" ratings, the insurer's ability to write new business has come to a virtual standstill. Continuing deterioration in housing and the economy, meanwhile, makes it more likely the company will face more claims on mortgage debt it has insured.
"The company's business model is essentially broken, it's not going to be able to underwrite any significant volume of new business at any point in the foreseeable future, which probably suggests runoff as being at least the near-term and intermediate status quo for them," said David Havens, desk analyst at UBS in Stamford, Connecticut.
"The credit market conditions continue to worsen and we're seeing a transition from unrealized losses into realized losses, which are going to in all likelihood adversely affect the solvency of the company," he added.
Even if the company survives, the downgrade itself is likely to lead to a myriad of credit derivative losses.
CDO UNWINDS
Ambac sold insurance on around $60 billion of corporate, sovereign, asset-backed and other debt, mainly using credit default swaps.
As concerns about the company's health increase, investors and banks that bought protection from Ambac may unwind their deals to offset the risk of Ambac's failure, JPMorgan said.
The insurer itself, meanwhile, is also referenced in around 55 percent of synthetic Collateralized Debt Obligations -- structured deals backed by credit default swaps, the bank added.
"Ambac's downgrade will likely lead to further rating downgrades in the synthetic CDO space, and its spread widening is causing further mark-to-market losses for these structured products," said JPMorgan's Beinstein.
Investors and dealers hedging, restructuring or unwinding these deals may send spreads on credit default swaps on individual companies and on indexes wider.
Meanwhile Ambac's Guaranteed Investment Contracts (GICs) were used as collateral posted against certain types of synthetic CDOs. And these may be forced to unwind as a result of the downgrade, Beinstein said.
"Even without failing to meet GIC's collateral requirements, Ambac's severe ratings downgrade will lead to synthetic CDO unwinds," he said. "As with the reference and counterparty risks, the collateral risk increases the pressure on spreads to widen across all credit derivative markets."
COMMUTATIONS
One potentially bright point for Ambac's liquidity would be if it makes agreements with counterparties to tear up contracts on risky residential mortgages.
Ambac said in a response to Moody's downgrade on Wednesday that the rating agency failed to account for the early termination of some of its contract exposures, and for federal efforts to improve the liquidity of financial institutions.
"Something that could change the game and prevent them from becoming even more unhealthy, would be to commute a substantial number of the chunky ABS CDO exposures and risks they have," said UBS' Havens. "That could very substantially improve their prospects." (Editing by James Dalgleish) For other related fixed-income quotations, stories and guides to Reuters pages, please double click on the symbol: U.S. corporate bond price quotations... U.S. credit default swap column........ U.S. credit default swap news.......... European corporate bond market report.. European corporate bond market report.. Credit default swap guide..............
Fixed income guide..................... U.S. swap spreads report............... U.S. Treasury market report............ U.S. Treasury outlook.................. U.S. municipal bond market report...... Keywords: MARKETS CREDIT
(karen.brettell@thomsonreuters.com; Tel: +1 646 223 6274; Reuters Messaging: karen.brettell.reuters.com@reuters.net)
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