ASSET-BACKEDS-ABX selloff to get uglier on Ambac cut

Friday, January 18, 2008 4:34:39 PM (GMT-05:00)

Provided by: Reuters NewsRTRS

By Nancy Leinfuss

NEW YORK, Jan 18 (Reuters) – A key derivatives index is likely to suffer another sharp blow in coming days as the market digests news of a ratings downgrade to bond insurer Ambac after a steep sell-off on mortgage-related losses at top U.S. investment firms this week.

Fitch Ratings slashed by two notches the top "AAA" rating of Ambac Assurance Corp, the insurance unit of Ambac Financial Group <ABK.N>us;ABK_N, citing its decision to scrap a $1 billion equity issue. Ambac Assurance’s rating was cut to "AA" from "AAA."

The bond insurer’s planned equity issuance was meant to shore up its balance sheet as securities linked to mortgages and other consumer debt suffer from higher-than-forecast losses. Fitch also downgraded parent company Ambac Financial’s long-term rating three notches to "A" from "AA."

Fitch’s action came after an early close for the U.S. bond market on Friday, ahead of the Martin Luther King Jr. Day holiday on Monday.

Market participants are expecting another sharp sell-off in the ABX, a synthetic index of U.S. home equity ABS tied to credit default swaps, when markets reopen on Tuesday.

"It’s going to get uglier," said one ABX trader, following news of Ambac’s downgrade on Friday.

Top-tier segments of the ABX 07-1 index, used by investors to hedge subprime mortgage risks, tumbled to record lows this week as Citigroup <C.N>us;C_N and Merrill Lynch <MER.N>us;MER_N reported large fourth-quarter mortgage-related losses this week.

The ABX 07-1 "AAA" tier suffered a 4.25-point drop this week, while the "AA" and "A" slices tumbled 4-3/4 points and 4-1/2 points, respectively, traders said.

Merrill reported about $16 billion in mortgage-related losses for its fourth quarter, making it the worst quarter in the company’s history. Citigroup also reported a $9.83 billion loss tied to subprime home loans and other risky debt for its fourth-quarter. The news added to growing concerns that the worst for financial firms inflicted by the global credit crisis may be far from over.

The riskiest "BBB-" slice of the same index was down 2-3/4 to 14.09 on Friday. The index has lost 85 percent of its value since it began trading early last year.

(Editing by Jonathan Oatis)

((Reuters Messaging: nancy.leinfuss.reuters.com@reuters.net; Tel: 646 223-6312))