Ambac's planned muni insurer may be hit by changes

CHICAGO, Sept 8 (Reuters) - Ambac Financial Group Inc's (ABK.N) plan to create a new municipal bond insurer by reactivating Connie Lee Insurance Co may be hampered by changes in the muni market, analysts said Monday.

These include a sharp move away from bond insurance by issuers after most guarantors, including Ambac, lost their triple-A ratings. The major ratings agencies cut their ratings on the big bond insurers because of their exposure to risky subprime mortgage-related securities.

In another even more fundamental change, agencies are mulling a shift in how they rate muni debt, using the same scale used for corporate debt. That would result in widespread rating upgrades for municipal bonds, which have a much smaller risk of default than corporate bonds. Higher ratings would in turn reduce the need for insurance.

"Given the franchise damage and rating downgrades sustained by much of the bond insurance industry over the past year, and Moody's (Investors Service) transition of its muni ratings to a global scale, the general outlook for new municipal bond insurance business appears uncertain," Merrill Lynch analysts said in a report.

Only 8.2 percent of muni bond issuance last month was insured compared to 53.1 percent in August 2007, they said.

However, the lack of timely and adequate disclosure by smaller and infrequent muni issuers could provide some future demand for bond insurance, "though only for providing underlying credit evaluation and credit evaluation surveillance."

Ambac, which is domiciled in Wisconsin, received approval last week from that state's insurance commissioner's office to reactivate and capitalize Connie Lee with $850 million, allowing it to operate as a separate corporate and legal entity within Ambac Financial Group.

The yet-to-be-renamed subsidiary will insure only prospective municipal bonds, as well as global essential infrastructure beginning in the fourth quarter, according to Ambac spokeswoman Vandana Sharma.

Ambac Assurance Corp will continue to back munis already carrying its insurance, she said.

Analysts at Municipal Market Advisors (MMA) said Connie Lee was unappealing even if the new insurer were to win "AAA" ratings from Moody's and Standard & Poor's Rating Services.

"(Triple-A) ratings would help Connie Lee write some new business, but we do not believe this particular insurer will be well received by the market," said MMA.

Analysts doubt that Connie Lee could sustain a "AAA" rating should Ambac, currently rated "AA" by S&P and "Aa3" by Moody's, be downgraded to below investment grade. They also speculate that Connie Lee would focus more on insuring bonds in the secondary market, "where wraps can be easily disengaged should Connie Lee's financial guaranty rating be cut."

Douglas Renfield-Miller, who will serve as the new unit's chief executive officer, said in a statement last week that the new insurer will fill a critical need, while redefining the financial guarantee business model with a clean balance sheet, a focused business plan, "strong corporate governance and unprecedented transparency." (Reporting by Karen Pierog; Editing by Jonathan Oatis)