Ambac Financial Group Inc. has agreed to pay Citi $850 million to settle one of its largest collateralized debt obligation exposures, improving the excess capital position of insurer subsidiary Ambac Assurance Corp., the companies announced Friday.

The agreement terminates the guarantee on a $1.4 billion collateralized debt obligation squared transaction, a CDO of a double-A rated CDO of asset-backed security tranches - most of which have now fallen below investment grade. Ambac Financial nevertheless expects to record a pre-tax $150 million gain on the settlement, because it had already recorded approximately $1.0 billion of mark-to-market losses on the instrument. It reports its second-quarter earnings Wednesday.

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