Sell Side

Ambac Reports $3.3B Losses in 4Q

Ambac Financial Group Inc. yesterday reported a net loss of $3.3 billion for the fourth quarter of 2007, based on a pretax mark-to-market loss of $5.4 billion in the company’s credit derivatives portfolio.

The loss was blamed in part on more than $1.1 billion in credit impairment related to collateralized debt obligations tied to mezzanine-level subprime residential mortgage-backed securities, caused by a recent evaluation and subsequent internal downgrade by Ambac of those securities to below investment grade.

The fourth quarter results did not come as a surprise to analysts or investors, as the company divulged the losses last week in announcing what was at the time its latest plan to raise $1 billion of capital. Fitch Ratings demanded the additional capital as a condition for Ambac Assurance Corp., the company’s financial guarantor, keeping its triple-A insurer financial strength rating.

Ambac later scratched the capital plan, which suggested raising capital through equity instruments, after Moody’s Investors Service placed it on watch for a possible downgrade. On Friday, Fitch downgraded Ambac Assurance to AA, with a negative watch, after the company said it could not raise the capital required by Feb. 1.

“We view the current perceptions of Ambac’s business by both the market and ratings agencies as underestimating Ambac’s strengths and future potential,” chief executive officer Michael Callen said during a conference call on earnings release.

Ambac yesterday also reported $304.5 million of new business production in the quarter, a 3% drop off the same quarter in 2006. Ambac measures it production through a non-GAAP measure, it calls credit enhancement production, or CEP, which it calculates by adding the premiums collected up front for new deals to the present value of what is expects to earn from those credits in future installments.

In its public finance division, Ambac reported $97.4 million in CEP, an increase of 16% over last year’s fourth quarter total of $84 million. The increase came from work on wrapping health care deals and municipal structured real estate, the company said in a release. On the year, Ambac’s public finance CEP increased 18% to $477.8 million over $405 million in 2006.

However, the strength in the quarter was front-loaded, the company said, because market penetration for bond insurance dropped dramatically during the month of December as the subprime-related losses began to affect the industry.

Ambac’s market share fell to 18% of all insured deals for the quarter, from 23% last year, based mainly on an erosion of confidence stemming from the review and subsequent rating actions undertaken by the rating agencies, Callen said in a conference call yesterday.

The slowdown has continued into this month as issuers shy away from the insurers and the many questions that remain. To date, Ambac is the third-busiest bond insurer in 2008, wrapping 5% of all insured deals in the month, or eight deals with a par of $172.7 million, according to data from Thomson Financial.

Ambac said yesterday that the $1.1 billion credit impairment for the fourth quarter came because the company chose an alternative strategy in evaluating the mezzanine level CDOs underlying the three CDO-squared transactions it wraps, and a fourth deal, that the company wrapped. Ambac took many lower-rated investment grade securities from those deals and assumed they were in default.

“We went into the high-grade deals and split out the vintage distribution and used that as a guide. For the second half of 2005 and onwards, we have doubled the correlation numbers,” said David Wallis, senior managing director, portfolio and market risk management. “When you take something that is investment grade and assume it has defaulted, that is pretty harsh.”

Analysts expressed concern that the same degradation could happen with the higher-rated securities. Callen said no claims have been paid on these deals, and that he expects to pay out $10 million, at most, in 2008.

In terms of a new capital plan, the company said it was seeking strategic alternatives with a number of parties.

The previous plan was based on equity and equity-linked securities and possibly debt, though many analysts now say those options are off the table because of market conditions. MBIA Inc., the parent of financial guarantor MBIA Insurance Corp., recently sold surplus notes to raise capital and then watched them lose as much as 20% of their value in the first days of secondary market trading.

In such an environment, Ambac is likely to seek an alternate solution. Help may come from insurance regulators, after New York state insurance superintendent Eric Dinallo released a three-part plan to bolster the bond insurance industry, which includes talking to “other parties about possible future capital investments.”

Ambac’s Callen said he was in close communication with regulators — including the Wisconsin Department of Insurance where the company is domiciled — about such a plan.

“We have been in close communication with [insurance] regulators and they are very familiar with what we are thinking,” Callen said. “We are talking to several parties, pools of capital.”

Dinallo’s statement contributed to a rebound in bond insurer’s stock price. At the close of trading on the New York Stock Exchange, Ambac stock was up 28.6%, or $1.77, to $7.97, while MBIA’s stock was up 46.55%, or $3.98, to $12.53.

Ambac spokesman Peter Poillon said the company will announce a new capital plan fairly quickly, and Callen said the company will continue to pursue a strategy based on the maintenance of a triple-A rating.

“Our product has been blemished,” Callen said. “That is what we are addressing here and what we’ll be addressing in the next two weeks.”


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