Ratings wobblers: Deutsche, FGIC, NAB, Mobius, XLCA

If NAB is feeling bruised and battered, Deutsche Bank must be feeling a whole lot worse. After announcing further write downs and impairment charges of €2.3 billion with its second quarter results on Thursday, S&P lowered its long-term credit rating a notch to 'AA-' and left the outlook on negative.

S&P considers the bank's performance is not materially stronger than that of its leading peers and therefore a higher rating was no longer justified. The negative outlook reflects the potential for a more precipitous deterioration in underlying business conditions.

Merrill Lynch announced further losses on its CDO portfolio, along with another sizeable equity raising. Moody's affirmed the A2/Stable/P-1 ratings assigned to Merrills, noting that while the sale of a substantial proportion of its CDO portfolio and the termination of associated hedges will result in a pre-tax loss of up to US$5.7 billion, it was a positive step in the de-risking of Merrills' balance sheet. It also results in a significant reduction of its most problematic exposures and the loss was within the range expected when Moody's downgraded Merrills earlier in the month.

(Merrills still holds US$8.8 billion of CDOs out of an original US$50 billion holding.)

In addition, the US$6 billion of new equity raised and the immediate conversion of US$5.4 billion of mandatory convertible securities was a significant step in bolstering the firm's capital adequacy. The new equity raised exceeds the amount of the loss and provides a cushion against remaining problematic positions.

S&P noted that the A/Negative/A-1 ratings it assigns to Merrill Lynch were unaffected. S&P said it had not given any equity credit to the mandatory convertible securities, therefore the conversion is beneficial in this respect, but further dilution of existing common shareholders could constrain future financing flexibility.

The unwinding of the hedges associated with Merrill's CDO hedges was, at least in part, driven by the precarious position Security Capital Assurance Ltd and its subsidiaries found themselves in, as a result of further provisioning for losses in their CDO portfolios. Consequently, Fitch implemented a multi-notch downgrade of the insurer financial strength ratings of SCA and subsidiaries, XL Capital Assurance Inc. (XLCA) (a credit wrapper that has been active in Australia and New Zealand) and re-insurance subsidiary, XL Financial Assurance Ltd. (XLFA).

XLCA was downgraded to 'CCC' from 'BB', with similar downgrades being made to the ratings assigned to the others. All the ratings have been left on Rating Watch Evolving, reflecting the uncertainty of the direction of the next rating moves.

The loss provisioning, as it is, will result in capital deficiencies being reported as at the end of the second quarter. This could trigger regulatory intervention, in which case Fitch would move the ratings to default.

However, if the termination of the hedges is implemented, realised losses will be considerably less than the provisions, thereby avoiding a capital deficiency.

Complicating this though, is the linking of a successful public offering of equity by an SCA subsidiary, as a condition precedent, and a requirement for the termination to be completed by August 15.

Despite concerns that Fitch also holds over the group's RMBS exposures, successful termination of the hedges could result in ratings being moved up several notches.   

Fitch has been quicker to move on the monoline insurers than the other rating agencies. S&P affirmed its 'BBB-' ratings on XLCA and XLFA, observing that the efforts of the group to stabilise capital positions had left the ratings on CreditWatch with negative implications, given the execution risks involved.

In an unrelated move, Moody's withdrew its ratings on some $220 million of XLCA credit wrapped bonds issued by Envestra Victoria Pty Ltd. The move was for business reasons and in accordance with Moody's policy of withdrawing ratings on XLCA wrapped securities, for which there is no underlying rating.

Fitch also lowered its insurer financial strength rating on Financial Guaranty Insurance Corporation (FGIC) (another credit wrapper that has been active in Australia and New Zealand) to 'CCC' from 'BBB' on the expectation of further deterioration in its RMBS portfolio, which could trigger regulatory intervention. Again the rating has been left on Rating Watch Evolving.

Needless to say, regulatory intervention would be a negative for FGIC's rating and would trigger an immediate termination of FGIC's CDS exposures at current market values. This would be likely to exceed FGIC's claim paying resources.

On the positive side, there is a US$600 million contingent gain on a CDO transaction, although this is currently under litigation. There are also on-going negotiations with re-insurers that could ultimately improve some policy-holder positions.

Allco Finance Group vehicle, Mobius NCM-04 Trust, had four tranches of notes downgraded by S&P as a result of continuing deterioration in the performance of the underlying portfolio of assets that support the notes. A high level of disputed insurance claims for defaulted loans and a significant charge-off to the Class G notes has reduced the available credit support to the higher tranches.

The rating action affected the following tranches: Class D to 'BB' from 'BBB/Watch Neg'; Class M to 'BB' from 'BBB/Watch Neg'; Class E to 'CCC' from 'BB/Watch Neg'; and Class F to 'CC/Watch Neg' from 'B/Watch Neg'. The Class F notes remain on CreditWatch Negative as they may be subject to charge-offs on further mortgage foreclosures.

Interestingly, the insurance on the defaulted loans that is now being disputed was provided by The Mortgage Insurance Company Pty Ltd - another Allco Finance Group company.

Finally, a rating action that has nothing to do with the credit crunch: Moody's revised the outlook on the 'Baa1' senior unsecured rating assigned to New Zealand electricity and gas distribution company, Vector Limited, to stable from developing. Vector has completed the sale of its Wellington electricity network for NZ$785 million and the proceeds will be applied to debt reduction.