After receiving court approval two weeks ago, Ambac Assurance Corp. on Monday proceeded with its plan to pay billions of dollars to major financial institutions in exchange for terminating volatile structured-finance products.
The junk-rated insurer has not written new policies since June 2008. Before the credit crisis, it was triple-A rated and held the market’s second-largest insured municipal bond portfolio. But its financial position began deteriorating in late 2007 after it suffered near-fatal losses from guaranteeing assets later dubbed “toxic.”
Some of the complex products were credit default swaps — insurance-like guarantees against default — on collateralized debt obligations of asset-backed securities. The insurer was prohibited from directly issuing CDS, but it did so indirectly by creating a non-insurer subsidiary, Ambac Credit Products LLC, and guaranteeing its financial obligations.
Under the settlement proposed in late March by the insurer’s regulator, the Wisconsin Office of the Commissioner of Insurance, Ambac will pay 14 major banks $2.6 billion in cash and $2.0 billion in surplus notes to commute, or tear up, those contracts, which have a face value of $16.4 billion.
“The settlement agreement includes covenants that remain in force until the AAC surplus notes have been redeemed, repurchased or repaid in full,” said parent Ambac Financial Group Inc. in a filing to the Securities and Exchange Commission.
The surplus notes yield 5.1% and are scheduled to mature in June 2020. Ambac has call options on the notes, allowing it to buy back up to $940 million of them at a weighted average price of 22 cents on the dollar.
“This settlement allows Ambac to reduce the amount of total claims by billions of dollars, to the direct benefit of the remaining policyholders,” said commissioner Sean Dilweg, who in late March took $35 billion of Ambac’s most toxic holdings and placed them into a segregated account to be administered by his office.
“It also allows the court-authorized rehabilitation process to continue, as planned, and supports our plans to implement a durable solution for all policyholders,” he added.
The settlement was unsuccessfully contested in state court by two parties: a group of hedge funds owning $1 billion worth of residential mortgage-backed securities insured by Ambac; and holders of Ambac-insured municipal debt issued by the Las Vegas Monorail Co.
Each said the settlement would give CDS policyholders preferential treatment and could leave the insurer without adequate capital to pay future claims.
The courts in Wisconsin, however, called those judgments “speculative.” They said tearing up the contracts at a fraction of their original value would help stabilize the company and benefit all policyholders.
Craig Guttenplan, an analyst at independent research firm CreditSights Ltd., said: “There is some validity to the fact that there is cash going out the door that would have been used to pay the claims, but at the same time it’s possible that Ambac would have had to pay more claims over the life of the contract.”
Noting that the current value of the contracts is disputed, he added that “it’s hard to really opine on what levels they are done at because we don’t have access to where Ambac has that deal marked, or where the banks have it marked. That’s all private information — it’s hard to tell if it’s an aggressive payout or not.”
Also in the announcement, Ambac said it paid $96.5 million in cash to tear up “certain additional obligations,” with undisclosed counterparties, for contracts with a face value of around $1.4 billion. It plans on paying $115 million in cash, plus $60 million in surplus notes, to commute another $1.5 billion of contracts within the next 12 months.
Guttenplan said paying to cancel the deals should be a net positive for the company, as reserves put aside for paying claims can be freed up for other use.
“It would not make sense for Ambac to consummate such a deal if it wasn’t accretive to capital,” he added.
The plan isn’t expected, however, to free up enough capital for the insurer to pay dividends to Ambac Financial, which in November said it may have to seek bankruptcy protection.
Ambac Financial said Monday that it may decide “not to pay interest on its debt” as early as the end of the current quarter, noting that a bankruptcy proceeding could take place with or without a prepackaged agreement with major creditor groups.
