Sell Side

Ambac Has $1.66B Loss in 1Q

Ambac Financial Group Inc., parent of bond insurer Ambac Assurance Corp., yesterday announced a net loss of $1.66 billion in the first quarter driven by losses on subprime-related securities the monoline guarantees, including nearly $1 billion dollars set aside by the company for claims it is likely to pay.

"The first quarter was indeed another tough one for Ambac," said chief executive officer Michael Callen on the conference call. "Our real disappointment during the quarter has been in segments of our direct [residential mortgage-backed security] book."

Ambac said the first-quarter results include $1.73 billion in mark-to-market losses for exposures to credit default swaps, used to insure collateralized debt obligations of asset-backed securities, as well as more than $1 billion in losses related to direct exposure to RMBS. Of the credit derivatives exposure, the company's expects to pay worst-case claims of $940.4 million.

For the quarter, Ambac reported $40.5 million of total new business production, down 87% from production of $310.1 million in the first quarter of 2007. Ambac measures its 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 it expects to earn from those credits in future installments.

In the public finance division, Ambac reported $5.5 million in CEP, a decrease of 95% from last year's first quarter total of $114.5 million. The decrease was a result of Ambac's ratings being on negative watch for the majority of the quarter, leading issuers to seek business with the other more stable triple-A rated insurers, the company said in a release.

The losses come in a quarter during which Ambac raised about $1.3 billion for the financial guaranty company and freed about $390 million more through ceasing to write new structured finance business and allowing some policy exposure to expire, the company said.

Executives believe that despite the losses, Ambac's capital position remains strong enough to maintain its triple-A rating and negative outlook from Standard & Poor's and Moody's Investors Service. Ambac said Monday it will ask shareholders to approve nearly doubling the number of authorized shares to 650 million from 350 million, which could be used to raise additional capital. Executives said there was no plan to tap the added capacity.

Standard & Poor's has said that Ambac's capital is above its AAA requirements by about $700 million, and Moody's said in March that the company exceeds its Aaa threshold, but falls short of the "target" number by about $700 million. With the $390 million that was freed up in the first quarter, Callen expects the same amount or more to be freed in the second quarter, putting Ambac over Moody's target.

"My sense is we will generate well north of $400 million by [the end of the second quarter] and that will put us over the top as far as Moody's is concerned," he said in the call.

"The losses that they've reported are within the losses that we were projecting, so this doesn't invalidate those projections," said Standard & Poor's analyst Dick Smith. "We aren't taking any rating actions at this time."

Fitch Ratings assigns a rating of AA, with a negative outlook, and has said that Ambac remains short of the triple-A level by billions of dollars.

The rating agencies have said in the past that they do not consider mark-to-market losses when looking at the ratings, though the decline in the residential housing market which so surprised Ambac executives could lead to credit actions, said Guy LeBas. fixed-income strategist at Janney Montgomery Scott LLC.

LeBas said "too much headline risk" associated with another quarter of big losses will prevent the bond insurer from writing significantly more business.

The bond insurer said Tuesday it has worked with clients on more than 100 transactions to refinance or restructure auction-rate securities or variable-rate demand obligations. Its efforts to amend liquidity facilities for VRDOs has caused Ambac-insured variable-rate paper to fall by as much as 100 to 200 basis points, the company said in a release.

Since raising the additional capital, Ambac has earned about $12 million on transactions in the public finance sector. This includes a number of deals in the negotiated market, a few more in the competitive issue market, and a "fair amount" in the secondary market, said Robert Shoback, senior managing director for public finance, on the conference call.

"We've seen most activity in the secondary market recently," Shoback said.

So far in 2008, Ambac has insured 17 deals for par value of $377.1 million, representing 1.3% of the insured market, according to data from Thomson Reuters.

Callen said he understands the bond insurer is suffering from a "crisis of confidence," that will only be lessened by one or two quarters of positive financial results. He said he expects to be writing new business by the beginning of 2009.

It is not clear, however, whether overall municipal market bond insurance penetration will ever return to what it was. Moves are underway to update the municipal ratings scale to better reflect the default rates as compared to other fixed-income securities, and if this takes place the market for bond insurance is likely to suffer.

"Depending on what happens with corporate equivalent ratings, those saying the bloom is off the rose for bond insurance may be understating it," said Richard Larkin, director of research at Herbert J. Sims & Co. "The long-term demand for bond insurance is weaker and on top of that you have a tarnished reputation."

Ambac stock closed down 43%, or $2.57, at $3.46 in trading on the New York Stock Exchange yesterday. The stock of MBIA Inc., parent of MBIA Insurance Corp., was down 33%, or $4.49, to $8.79 in trading on the NYSE yesterday, after the Ambac earnings release.



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