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Q

It looks like a lot of things are going on with bond insurers. What are your views on Ambac and MBIA? Can they survive this turmoil? What does the future look like?

A

James A. Klotz responds:

While we are optimistic that both Ambac and MBIA will likely survive the current mortgage crisis, we are in no way confident as to what the future may hold. The municipal bond side of both companies is performing well, as they always have. The problem is rooted in their exposure to the sub-prime and Collateralized Debt Obligation mortgage market. The rating agencies, who are in a position to have detailed knowledge of these exposures, have zig zagged between assurances that the insurers would not be touched by the mortgage crisis to outright downgrades of the insurers just a few months later. The downgrades resulted in collateral calls and further loss of credibility and stock value for both MBIA and Ambac. At this point, both insurers carry ratings in the “AA” or “A” categories with either a negative watch or negative outlook. The future of both companies will depend heavily on how much of their mortgage exposure actually results in real dollar losses and where that leaves their capital levels.

The rating agencies base ratings of bond insurers on three main factors: capital levels, quality of insured portfolios and business prospects. Currently, capital levels (incorporating expected losses) are below that needed for an “AAA” level rating, although they are adequate to meet anticipated claims. Business prospects are rated as poor since little new business is being underwritten without the “AAA” ratings issuers have come to expect.

Without regaining their prior status as “AAA” level bond insurers, both Ambac and MBIA are unlikely to remain as major players in the new business side of the bond insurance industry.  They could remain solvent with their insurance in force in what the industry calls “run off” mode. This is the likely scenario we see, but don’t rule out either a better or worse eventual outcome. In any case, their portfolios continue to perform well since the vast majority of Ambac and MBIA bonds are of high quality on their own and continue to meet their debt service obligations as they always have.