The Wall Street Journal-20080118-Under Review- Ripple Effects Of Much Harsher Debt Ratings
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Under Review: Ripple Effects Of Much Harsher Debt Ratings
Debt-rating firms try to ignore noise in the financial markets when making judgments about a company's credit-worthiness. Lately, though, they've been causing quite a racket themselves.
Shares of bond insurer Ambac Financial Group fell 52% yesterday, sunk by an announcement from Moody's Investors Service Wednesday night that the rating firm had grown more worried about Ambac's outlook. The concerns led the Moody's Corp. unit to put Ambac bonds on review for possible downgrade, barely a month after Moody's finished a top-to- bottom analysis of the bond-insurance industry -- and affirmed Ambac's top rating of Aaa.
While the change of heart underscores how fast the credit crisis is spreading, it is also fueling complaints about the debt-rating industry. After being attacked for moving too slowly to downgrade mortgage-related bonds last year, Moody's and rival rating firms, some critics say, are worsening the market's instability.
"The problem with the rating agencies is that they've been behind the ball, not only with the guarantors but with the whole mortgage sector, and now they're playing catch-up," says Rob Haines, an analyst at research firm CreditSights. "Fair or not, they've been changing the rules periodically."
Mr. Haines points to the Standard & Poor's announcement this week that it was increasing its estimate of losses on subprime mortgages made in 2006. The McGraw-Hill unit also said it would reassess the capital levels of bond insurers, even though the rating firm issued assessments based on lower loss rates in mid-December. "Less than a month later, they're changing the assumption, and obviously it's becoming more punitive to the bond insurers," Mr. Haines says.
Debt-rating firms deny that they are being extra tough now to make up for being too rosy about the mortgage market before the credit crisis. "Our ratings opinions are not intended to be static," an S&P spokesman says. "When the credit performance of assets backing a security diverges significantly from our original assumptions, we take action to update our analysis. This is what the market expects from us."
Rating firms often get criticized both for moving too slow and for moving too fast. Moody's says its decision to put Ambac on watch for possible downgrade was triggered by the New York bond insurer's announcement early Wednesday of an expected $5.4 billion pretax loss on its credit-derivative portfolio in the latest quarter. Moody's analysts also were rattled by the abrupt resignation of Robert Genader, Ambac's chairman and chief executive, which was effective immediately.
"There's a great deal of volatility in mortgage-related CDOs and in the mortgage markets in general," says Jack Dorer, a Moody's managing director. "And the news over the past several months has not been getting better, but has been getting worse. Our process is to assess new information as it comes to us."
The fate of the bond insurers could ripple across markets such as municipal bonds and bank stocks. While major bond insurers such as Ambac, MBIA, Financial Guaranty Insurance and Security Capital Assurance aren't household names, they insure the payment of many mortgage-related investments and tax-exempt bonds issued by cities, states or counties. If their ratings are lowered, the value of many of these bonds would fall, causing big losses for investors.
Earlier this week, S&P significantly worsened its bleak outlook for bonds issued in 2006 that are backed by subprime mortgages. That change, it said, could affect a wide variety of bonds and financial companies, including the bond insurers.
Janet Tavakoli, president of Tavakoli Structured Finance, says the rating firms aren't sending "a consistent message" on bond insurers. She thinks they still are "afraid" to issue downgrades because "they don't want to create a liquidity crisis in the muni-bond market." Eventually, though, some bond insurers could be forced to restructure to preserve their municipal-bond businesses, she says. That would mean letting the insurers' CDO businesses fail.
CDOs, or collateralized debt obligations, are responsible for a big chunk of the crumbling confidence in bond insurers. In many cases, the insurers pledged to cover losses on certain CDOs tied to shaky sectors of the housing market. Now that the housing market is declining, insurers could be on the hook for potential claims. And if the insurers lose their ratings, the value of their guarantees and the CDOs would fall, causing billions of dollars in losses for Wall Street banks that bought the insurance for their CDO portfolios.
In mid-December, when Moody's reaffirmed Ambac's rating and its "stable" outlook, the rating firm was more optimistic than S&P and Fitch Ratings, a unit of Fimalac of Paris. S&P placed Ambac's coveted triple-A on negative outlook. By now putting Ambac bonds on review for possible downgrade, Moody's is taking a more pessimistic stance than if the firm just issued a negative outlook. Reviews for downgrade usually lead to a decision within one to three months.
Yesterday, Ambac shares plunged by as much as 65% before settling at $6.24 in 4 p.m. composite trading on the New York Stock Exchange, down 52%. MBIA fell $4.18, or 31%, to $9.22.
In a statement in response to the Moody's ratings action, Ambac indicated that a $1 billion capital-raising plan that it announced Wednesday might not proceed as scheduled. Selling cheap shares or raising debt as a triple-A-rated, stable issuer is typically much easier than giving a sales pitch under a looming downgrade.
"In view of the uncertainty generated by Moody's surprising announcement, Ambac is assessing the impact of this action on the company's previously announced capital plan," the company said.
