Downgrade due in part to losses in reinsured subprime, mortgage-backed securities and CDOs

Standard & Poor’s has lowered the financial strength and financial enhancement ratings on RAM Reinsurance from ‘AAA’ to ‘AA’ and removed these ratings from CreditWatch. S&P’s outlook on the ‘AA’ rating is negative.

In its report, S&P stated that the ‘AA’ rating reflects its view of RAM Re’s weakened capital adequacy position, which is the result of a significant amount of projected losses relating to reinsured subprime and residential mortgage-backed securities (RMBS) and asset-backed security collateralised debt obligations (ABS CDOs).

The company's capital adequacy margin of safety was in the range of 1.0x-1.1x, which exceeds S&P's 'AA' requirement of 1.0x. The rating also reflects S&P’s expectation that RAM Re will continue to maintain strong reinsurance relationships with the primary insurer community in the wake of its rating downgrade.

S&P stated that lastly, the rating reflects its understanding that RAM will continue to take proactive steps toward improving its historically below-average return on equity (ROE). S&P stated that the negative outlook for the ‘AA’ rating reflects S&P’s view that, in light of the unprecedented level of mortgage market deterioration that has occurred, S&P remains circumspect about assigning stable outlooks to insurers even if they have sufficient capital when measured against its projected stress case losses.

Accordingly, the rating agency stated that it will assign negative outlooks to those firms with significant exposure to domestic nonprime mortgages and/or meaningful lower credit quality exposures. The rating and outlook would be reassessed in the event RAM Re's sub-prime exposure deteriorates further and strains the company’s claims paying resources.

Commenting on S&P’s action, Vernon Endo, president and chief executive of RAM said, “We are disappointed but not surprised by S&P’s ratings action. We believe that the financial guaranty reinsurance industry in general is now considered to be a AA industry by the rating agencies and all of our major competitors are rated AA. At the AA-level, we provide 70% reinsurance credit to our AAA-rated customers, without taking into account any potential benefit of the trust agreements we have in place on behalf of our US-regulated customers. While some of our customers have the right to terminate our treaties and re-assume their business with us after a cure period has expired, we do not expect any of our customers to exercise this right in the near term, if at all. As a result of the downgrade, and assuming business is not recaptured, under current treaty terms we estimate the increase in ceding commissions to result in a one time reduction of $5.6m on unearned premium. We estimate that commission expense going forward will increase on average about 2%. We continue to make progress on limited, negotiated re-assumption transactions with our customers to improve our capital position and, in the course of those discussions, we will address the downgrade consequences as well.”