Ambac Subprime Contracts Taken By Wisconsin Insurance Regulator

By Sarah McDonald and Bryan Keogh
Bloomberg News
March 25, 2010

March 25 (Bloomberg) -- Ambac Financial Group Inc.'s bond insurance unit will hand control of subprime mortgage-related contracts to a regulator amid concern the second-largest bond insurer's collapse would trigger losses for municipal noteholders.

Ambac Assurance Corp., which guarantees $696 billion of debt payments, will set up a segregated account for insurance contracts linked to credit-default swaps, residential mortgage- backed securities and other structured finance transactions, the parent company said in a statement. The Wisconsin Office of the Commissioner of Insurance ordered the handover to "protect policyholders, including investors in thousands of state and local municipal bond issues," according to a separate statement.

"While there's clearly significant uncertainty, the potential outcome of these actions for Ambac Assurance is positive in that it may emerge stronger and without the threat of rehabilitation hanging over it," said Michael Cox, a structured-finance strategist at Chalkhill Partners LLP in London.

Ambac, created in 1971 to insure debt sold by states and municipalities, lost its top credit ratings and 99 percent of its stock-market value after expanding from its main business into guaranteeing bonds backed by riskier assets and collateralized debt obligations. The company said that while it doesn't consider the regulator's move to constitute a default, it may consider a "prepackaged bankruptcy."

$35 Billion

The securities coming under control of the regulator total about $35 billion, the Wall Street Journal reported, without saying where it got the information. The regulator will suspend payments totaling about $120 million for March to holders of the contracts, the newspaper said.

Susan Oehrig, managing director of media relations for Ambac Financial, didn't immediately respond to voicemail and e-mail messages left outside U.S. office hours.

Ambac Assurance has agreed to pay $2.6 billion in cash and $2 billion of surplus notes to settle with counterparties on collateralized debt obligations, the parent company said in today's statement. CDOs package pools of securities, including those backed by subprime mortgages, and slice them into pieces of varying risk.

"I have a concrete plan for rehabilitation, and details will be reviewed in court over the coming weeks," Wisconsin Insurance Commissioner Sean Dilweg said. Ambac Assurance's exposure to securities that soured amid the deepest financial crisis since the Great Depression "reduced its claims-paying resources," according to the regulator.

Sufficient Liquidity

Ambac Financial has sufficient liquidity to satisfy its obligations until the end of the second quarter of 2011 and said it may consider a "negotiated restructuring of its debt through a prepackaged bankruptcy proceeding or may seek bankruptcy protection." The New York-based company had stated in a November earnings filing that it may seek bankruptcy protection.

Ambac sold the industry's first insurance policy on municipal debt 39 years ago, for a $650,000 bond of the Greater Juneau Borough Medical Arts Building in Alaska. The business thrived, with a handful of companies obtaining the top AAA credit rating needed to guarantee debt of state and local governments and their agencies that seldom defaulted.

Ambac Assurance was stripped of its top ratings in 2008 and has since seen its grade cut 17 levels to Caa2 by Moody's Investors Service.

Insurer Splits

Other bond insurers have split off their more troubled structured finance guarantees from their municipal bond obligations. MBIA Inc., the No. 1 bond insurer, said in February 2009 that it would divide its insurance business into two companies following the loss of its top credit ratings.

Ambac Financial's stock plunged 99 percent since May 2007, falling from a peak of $96 to 79.6 cents as of yesterday.

Credit-default swaps on Ambac Assurance were little changed at 60.5 percent upfront, according to CMA DataVision. That means it costs $6.05 million in advance and $500,000 a year to protect $10 million of debt for five years. Contracts on MBIA Insurance Corp. rose 1 percentage point to 51.25 percent upfront.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

Mutual funds holding $20 billion of municipal debt guaranteed by Ambac Assurance hired Hartford, Connecticut-base law firm Bingham McCutchen LLP to represent their interests in a possible restructuring.

Ambac Assurance U.K. Ltd. said in a statement that it's reviewing all its contractual relationships with Ambac Assurance and that it will remain able to meet all its obligations as they fall due.

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