What Should Connie Lee Be Rated?

Just a short post, but there are two reasons why Connie Lee should not get a AAA from the rating agencies (Aaa if you speak Moody’s):

1) It violates their notching standards.  A parent company with a senior unsecured debt rating of A/A3 should only get ratings of AA/Aa3 maximum.  This is because a holding company can only provide so much incremental support to a subsidiary, so the degree of enhancement to a well-capitalized subsidary should only be three notches, particular given that there may come a time when the parent company is incapable of adequate support, and the subsidiary is in need as well.

Connie Lee is a small insurance company with a weak parent company.  Small insurers always get weaker ratings than large insurers, unless they have a deep-pocketed parent.

Now, maybe the rating agencies will say that because Ambac can now write new municipal guarantee business, the holding company itself deserves a higher rating, like AA-/Aa3, and thus Connie Lee can get a AAA/Aaa.

2) Connie Lee has no track record of its own, and many on the management team that made the faulty decisions at Ambac, Inc. are still in place.  Yes, they managed their muni business well, but what if they go down the same diversification path again?  Regulators have short memories, and they do move on to other pursuits after some time.

It seems that Connie Lee will be a subsidiary of Ambac Assurance, so fraudulent conveyance issues are probably dead.  If Ambac Assurance were unable to pay all claims, Connie Lee could be sold, and the proceeds used to help pay claims.

It will be interesting to see what the rating agencies do with this.  It would be in their short-term profit interest to make Connie Lee AAA/Aaa, but they’ve been burned by Ambac before.  If they make Connie Lee AAA/Aaa, they should get complaints from others alleging unfair notching.  Also, to give them a AAA/Aaa would be to put the rating agencies own business models at risk if something more goes wrong at Ambac, and their new notching means they have to downgrade Connie Lee.

If I were in the shoes of the rating agencies, I would wait to see how the non-municipal guarantee business matures over the next two years, particularly given softness in the residential real estate markets.  Then, if Ambac Assurance began to look healthier, I would consider upgrading it and Connie Lee, one notch at a time.

PS — maybe larger municipalities will finally be weaned from needing insurance, and this market will amount to still less in the future…