Sell Side

Ambac to Sell Stock, Options

Ambac Financial Group Inc. yesterday announced a $1.5 billion offering of common stock and equity units in an effort to shore up its capital reserves and preserve the rating of its financial guarantor, Ambac Assurance Corp.

The stock offering is expected to net the company $1 billion, while the equity unit offering for each $50 unit is expected to raise $500 million. The offerings are being underwritten by Credit Suisse Securities LLC, Citigroup Inc., UBS Securities LLC, Banc of America Securities LLC, Keefe, Bruyette & Woods Inc., BNY Capital Markets, and KeyBanc Capital Markets.

Ambac will funnel all but $100 million to the bond insurer, to support its triple-A rating.

"One advantage of this stock offering is that the money flows back in to all the policyholders," said Sean Dilweg, the commissioner of insurance for Wisconsin, the state where Ambac is domiciled. "I am confident in speaking to management that they will hit their target and hopefully exceed their target."

As part of the offering statement, Ambac said it will cease writing any new structured finance business for the next six months. Included in the sweeping promise, the bond insurer said it will discontinue underwriting collateralized debt obligations, credit default swaps, collateralized loan obligations, asset-backed securities, or securitizations of assets such as student loans or rental car fleets.

In announcing the move, Ambac showed that it is no longer considering a split of the company into two businesses - with one made up of the municipal business and the other with the structured finance business - for the time being.

"I think there is still a desire [to split in two] - its more in the policy arena, I hear it from Congress and my fellow regulators - so we may look at it down the road but the immediacy of doing it today or tomorrow is off the table," Dilweg said.

He went on to say that in the coming months he will also examine the role of the rating agencies on the business prospects of Ambac. From a regulator's standpoint, a rating downgrade is not a problem in itself, only when it directly affects the company's solvency, as it does with the financial guarantors.

"How do we, as regulators, account for the rating agencies?" Dilweg said. "It's a key part of any business plan they do, and I think we'll spend some time looking at that down the road."

The rating agencies seemed to accept Ambac's plan in the short term, with all three of them saying that if the insurer succeeds with raising the $1.5 billion, the agencies could foresee taking the company off of negative watch. For the time being all three kept the ratings unchanged.

Ambac is rated Aaa by Moody's Investors Service, AAA by Standard & Poor's, and AA by Fitch Ratings.

Moody's released a statement after Ambac announced its plans, saying that a successful pricing of at least $1.5 billion would be enough for Ambac to preserve its triple-A rating. Standard & Poor's also said something similar, though it would likely keep the company on negative outlook because of uncertainty about the bond insurer's exposure to subprime mortgages going forward.

"The negative outlook would reflect our view that the potential for further mortgage market deterioration remains uncertain and will likely challenge bond insurers' ability to gauge their ongoing capital needs accurately in the near term," Standard & Poor's said in a statement.

In its filings with the Securities and Exchange Commission, Ambac said that some members of its underwriting team, as well as other market participants, have estimated the insurer's losses "materially exceed" those already announced.

"The important thing is this is new money that they could take in and downstream those funds to the benefit of the insurance company," said Fitch managing director Tom Abruzzo. "We would likely remove the rating watch negative, which I think takes away some of the shorter-term uncertainty."

However, Abruzzo said Fitch would keep Ambac at AA, reflecting the company's need for more than capital to garner a AAA. Fitch said Ambac would have to do more to mitigate its risk of exposure to subprime-backed CDOs, either through reinsurance or with some other mechanism.

"We don't think this is a AAA name right now," Abruzzo said.

Further details of Ambac's SEC filing show its underwriters will have a 30-day option to purchase any additional shares or equity units to cover over-allotments of the offerings, which are aimed at the longtime stockholders who have stayed with the company throughout the recent troubles, Ambac chief executive officer Michael Callen said in a statement.

The equity units that Ambac announced will consist of a purchase contract and an ownership in senior notes due in 2021, which allows the holder to buy newly issued shares or shares of preferred stock in 2011. The senior notes will be remarketed prior to the purchase, the company said.

Market participants also had doubts about the plan, with some questioning whether this effort would be enough capital to stabilize Ambac's ratings and assuage the municipal market. Several said they were "underwhelmed" by the announcement.

In January, Ambac proposed a $1 billion capital-raising plan, only to take it off the table because of what it said were unfavorable market conditions. Leading up to this announcement, many market sources expected Ambac to announce a plan to raise between $2 billion and $3 billion. The specter of further subprime-related losses continues to loom.

"The raters continue to hedge their bet with a negative outlook, primarily because they are concerned that there could be further deterioration in the subprime mortgage market, which they have not captured in their latest in a long series of "worst-case" scenarios," said Dick Larkin, senior vice president and director of research at Herbert J. Sims & Co. "I don't feel that today's announcements by Ambac and the bond raters give me any more comfort that the bond insurance credit crisis is now behind us."

Last year, fellow bond insurer CIFG Guaranty raised $1.5 billion in capital from its French bank parents, only to have its rating placed on review for possible downgrade by Moody's, and on negative watch by Fitch, earlier this month.

"It's not exactly a bailout, it's an injection of cash, and they will probably need more later," said Matt Fabian, managing director at Municipal Market Advisors. "Looking at the credit situation, it is not getting any better."

Among the offering statements, Ambac listed a number of risk factors associated with owning the shares.

They included a lack of assurance that it will maintain its current ratings or see upgrades, and a recognition that there exists a threat of collateral postings associated with investment agreements and swaps upon further downgrades. The filings also listed as risks any subsequent changes to the rating agencies' capital models or rating methodology or amendments to state insurance regulations concerning financial guarantors.

Ambac shares fell 18.8%, or $2.02, to $8.70, in trading on the New York Stock Exchange yesterday.


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