This story starts with Monday’s headline: Fitch May Downgrade Bond Insurers After New Test.

Fitch Ratings may lower the AAA credit ratings on one or more bond insurers after a new review of the companies’ capital takes into account downgrades of collateralized debt obligations that they guarantee.

Fitch said it will spend the next six weeks reviewing the capital of insurers including MBIA Inc., Ambac Financial Group Inc., CIFG Guaranty and Financial Guaranty Insurance Co. to ensure they have enough capital to warrant an AAA rating. Any guarantor that fails the new test may be downgraded within a month unless the company is able to raise more capital, New York- based Fitch said today in a statement.

CIFG and FGIC, the bond insurer whose owners include Blackstone Group LP, have the highest probability of suffering erosion in the capital because of the falling value of CDOs, Fitch said. Ambac has a “moderate probability” and MBIA is at “low” risk, Fitch said.

“Fitch recognizes that financial guarantors view maintenance of their ‘AAA’ ratings as a core part of their business strategies, and management teams will take any reasonable actions to avoid a downgrade,” the statement said.

Please read that last sentence again.

Fitch is explicitly admitting that it is making rating decisions not on merit alone, but on perceived implications of what a rating change might do to the company being rated.

Earlier this year Fitch Disclosed Its Fatally Flawed Rating Model was based on an assumption that housing prices would rise at a steady rate forever.

Morgan Stanley’s Zerbe Does An About-Face on Ambac

Ambac is rebutting Zerbe’s Estimate of CDO Losses.

Ambac Financial Group Inc., the bond insurer that last month posted its first net loss because of mortgage-related securities writedowns, is fighting back against a Morgan Stanley analyst who said the company may go out of business. The shares rose the most since 1991.

The company, the world’s second-largest bond insurer, put a rebuttal on its Web site today disputing comments by Morgan Stanley analyst Ken Zerbe last week that Ambac faces a “downward spiral.” Ambac said Zerbe’s estimate for losses on securities it guarantees is based on an inaccurate assessment of its portfolio.

What would you expect Ambac to say? And who is rating the raters?

Nationally Recognized Statistical Rating Organizations (NRSRO)

Currently there are three (NRSROs)

  • S&P;
  • Moody’s
  • Fitch

Let’s consider a few Flashback Facts

  • Enron was rated investment grade by the NRSRO’s four days before bankruptcy;
  • The California utilities were rated “A-” two weeks before defaulting;
  • WorldCom was rated investment grade three months before filing for bankruptcy;
  • Global Crossing was rated investment grade in March 2002 and defaulted on loans in July 2002;
  • AT&T; Canada was rated investment grade in early February 2002 and defaulted in September 2002;

Egan Jones Says MBIA, Ambac Losses Will Be “Massive”.

Bond insurers including MBIA Inc., Ambac Financial Group Inc. and ACA Capital Holdings Inc. face “massive losses” over the next few quarters that could test their ability to raise new capital, Egan-Jones Ratings Co. said.

MBIA may lose $20.2 billion on guarantees and securities holdings, Sean Egan, managing director of Egan-Jones, said on a conference call today. ACA Capital may take losses of at least $10 billion; New York-based Ambac may reach $4.3 billion; mortgage insurers MGIC Investment Corp. and Radian Group Inc. may see losses of $7.25 billion and $7.2 billion, respectively, Egan said.

“There is little doubt that the credit and bond insurers face massive losses over the next few quarters and many will be capital challenged,” Egan said.

It will be difficult for the insurers to raise capital given the size of losses compared with the companies’ public shares, Egan estimates. In the case of ACA, Egan said the expected loss was 100 times the $122 million value of its outstanding shares.

The bond insurers have guaranteed more than $1 trillion of bonds issued by U.S. cities and states as well as bonds and securities backed by mortgages, credit cards and other assets, and the guarantee allows borrowers to use the insurers’ AAA rating.

Notice the discrepancy? Egan Jones says MBIA may lose $20.2 billion on guarantees and securities holdings while Fitch says MBIA is at “low” risk of a debt downgrade.

The numbers given by Sean Egan are nothing short of amazing, and should the numbers be anywhere in the ballpark it will be the end of the line for Ambac (ABK), MBIA (MBI), ACA Capital (ACA), MGIC Investment Corp. (MTG) and Radian Group Inc. (RDN).

Inquiring minds might be asking “Why should anyone trust Egan Jones?” It’s a good question. The reason is Egan Jones gets paid on the accuracy of its analysis. Moody’s, Fitch, and the S&P; all get paid by those companies whose debt they rate.

While Fitch is pussyfooting around with semantics as to what constitutes “reasonable actions” based on an expressed desire to not downgrade Ambac and MBIA, Egan Jones (credibility on the line) is willing to call them as it sees them.

Is there any credibility left at Fitch? For that matter is there any credibility in the entire NRSRO rating system? I think you know the answer to both. It’s Time To Break Up The Credit Rating Cartel.

Mike Shedlock / Mish
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