The major bond insurers MBIA (NYSE:MBI) and Ambac Financial Group (NYSE:ABK), got a big boost from Standard & Poor's on Monday, as the agency reaffirmed its 'AAA' credit ratings for both companies.
This was comforting news for investors, who sent shares of the insurers up, but questions still remain, and the hoopla seems a bit premature. I don't want to seem overly pessimistic, because I do feel there are selective areas of the markets where good buys can be made, but I don't include the bond insurers in that group. (To learn the basics of how corporate credit ratings work, see What Is A Corporate Credit Rating?)
Nothing has Changed
Following the announcement from Standard & Poor's (S&P), a unit of McGraw Hill (NYSE:MHP), shares of Ambac rose about 16% to $12.41 and MBIA rose nearly 20% to $14.58. However, these stocks are still down 80% and 75% over the past six months, and for good reason. The companies had a beautiful, albeit boring, business of insuring municipal bonds. Municipal bonds basically never default, so these two companies are making profits from insuring sure things.
This is a business Warren Buffett is now entering with Berkshire Hathaway (NYSE:BRK.A) grasping for those free profits. But like many in the market, the management at MBIA and Ambac got greedy for more growth and decided to decimate their status by insuring risky structured investment vehicles. (For more on the insurers' date with the devil, check out Fatal Seduction Of The Municipal Bond Insurers.)
Their foray into the exotic has called into question the stellar credit ratings of the insurers. If the questions result in a downgrade, this would have repercussions far from the balance sheets of just these two. Now S&P says the companies are 'AAA' despite their problems and the markets jump for joy. However, Ambac is still being observed for a downgrade, and S&P has not been ahead of the curve with its ratings calls during the credit crunch.
Both S&P and Moody's Corp (NYSE:MCO) had structured investment vehicles rated as 'investment grade' until it was all but certain they were going bankrupt. I am not buying S&P's recommendations. Questions have been swirling about the financial stability of the bond insurers, and while the companies may not go under, there has been no sudden turnaround.
AAA or Not, Bond Insurers are Risky
We are not out of the storm yet, and the bond insurers still have a lot of cleaning up to do. After the ratings news, MBIA released its plans to stay afloat, and while the moves are necessary, it is still not a pretty situation for the stock. Newly crowned CEO Jay Brown announced that the company will completely cut its dividend to help shore up some of the capital to pay its obligations. He also announced a five-year restructuring plan that will involve breaking apart its structured finance group.
S&P's motivation for leaving the ratings unchanged was that both companies will be able to raise enough money to continue meeting those obligations. This is good for the markets, but dilutive to the shares of these companies. These stocks are down so much, not because of rumors, but because the companies have been losing dump trucks of money the last few quarters. These stocks are in the gutter, but that doesn't make them a bargain. (What goes down doesn't always come back up; to learn more, see The 5 Biggest Stock Market Myths.)
The Bottom Line
S&P reaffirmed its 'AAA' ratings on troubled bond insurers MBIA and Ambac. This helped boost the market Monday and gave a big lift to the shares of these companies. While I don't think the bond insurers are doomed, they will struggle for some time. As these companies continue to raise capital and dilute their shares to remain viable, I would stay away.