Ambac Financial Group Inc. said yesterday its recapitalization plan for its muni-only bond insurer Connie Lee Insurance Inc. has been well received by the market, and it expects the insurer will begin writing new business as early as Oct. 1.
Ambac should receive a response from Wisconsin insurance regulators on its plan shortly. In the meantime, the company's discussions with market participants have convinced it demand for Connie Lee's product will exist.
"There's nothing I've seen that suggest that will be a problem," said chairman and chief executive officer Michael Callen.
The comments came during a conference call on second-quarter earnings in which Ambac said it posted a second-quarter net income of $823.1 million, thanks in large part to mark-to-market gains on credit derivatives as a result of a recent change in accounting rules.
Ambac Financial, the parent of bond insurer Ambac Assurance Corp., said it had mark-to-market gains of $961.6 million in the second quarter, helping it record a net income equivalent to $2.80 per diluted share. Net income in the second quarter last year was $173 million, or $1.67 per share.
The company attributed the large mark-to-market gains to an accounting rule that bases the discount rate on the fair value of derivative liabilities on the market's perception of the risk of Ambac's non-payment. Widening of credit default swap spreads on Ambac debt as a result of ratings downgrades led to the gain as of the end of June, whereas Ambac would have reported a $1.3 billion loss if it had calculated the value using its CDS spreads as of July 31, when they had tightened significantly.
Excluding these gains and others on the sale of investments, Ambac Financial posted an operating loss of $1.53 per share. Estimated impairment losses in its credit derivative portfolio totaled $1.06 billion in the second quarter, reflecting credit deterioration and internal downgrades on several transactions.
Ambac also recorded large gains on accelerated premiums due to refundings. Excluding these payments, core earnings fell to a loss of $1.83 per share.
"The tumultuous credit markets continue to negatively impact the estimated impairment value of a few of our" collateralized debt obligations, Callen said in a statement.
Ambac is "active" in talks to settle its exposures to certain transactions, chief risk officer David Wallis said. Last week, Ambac announced it paid Citi $850 million to terminate the guarantee on a $1.4 billion CDO-squared transaction, resulting in a $150 million third-quarter gain and improving the capital position of Ambac Assurance.
"We're not desperate to do deals just for the sake of doing deals, they have to be good deals, and we expect the market is intelligent and will be able to make that judgment," Callen said in the conference call, noting counterparties appear more willing to make deals, increasing liquidity and reducing bid-ask spreads.
Ambac also said it has stepped up efforts to remediate its residential-mortgage backed securities exposures based on breaches of representations and warranties. Consultants have already started to examine individual loans, and estimated recoveries on a present-value basis totaled $263 million on eight second-lien collateral transactions, Ambac said.
Analysts from Bank of America Securities LLC wrote in a report last week they expect more insurers to adopt this strategy.
"It is our view that the financial guarantor's actions along these lines will reap favorable accounting and economic benefits," wrote analysts Michael Barry, Seth Levine, and Brian Turner.
Ambac continued to write minimal business, with credit enhancement premiums - the gross up-front premiums plus the present value of estimated installment premiums on products issued - falling to $19 million from $368 million in the second quarter last year.
Ambac hopes the recapitalization of Connie Lee will break this trend, as the company will be an independent entity with a clean balance sheet. Overall demand for bond insurance has fallen, though, with just 22.3% of new issues insured this year, compared to 48% at this point last year, according to Thomson Reuters data. Moody's Investors Service said last week that market participants have told it penetration could increase to as high 35% in a market with muni-only insurers.
The "major hurdle" remaining for Connie Lee is receiving triple-A, stable ratings from Moody's and Standard & Poor's, Callen said. He said the company has already had discussions with the agencies and remains confident it can achieve top ratings.
"They are putting us through the wringer, but I honestly believe we are up to that task," Callen said.
