"Mismanagement" and "greed" on the part of Ambac Assurance Corp. has prevented the insurer from meeting "its obligation to provide credit enhancement" and cost New Orleans more than $2 million, according to a lawsuit filed by the city in federal court July 17.

The city has sued both Ambac and UBS Securities LLC, alleging Ambac's decision to back risky structured finance products and UBS's failure to remarket $171 million of taxable pension revenue variable-rate demand obligation bonds is costing the city $400,000 a month in increased interest payments. The suit was filed in the U.S. District Court for the Eastern District of Louisiana.

New Orleans said it paid a $6.4 million premium to Ambac in 2000, assuming the credit enhancement would allow the bonds to be continually remarketed. But Ambac's exposure to collateralized debt obligations of asset-backed securities and other risky structured finance products led to its downgrade and weakened its standing as a credit enhancer, the suit says.

"[Ambac] would not have lost its credibility as a financial guaranty insurer and, hence, provider of credit enhancement, if it had not mishandled its underwriting risk management in connection with its insurance of [structured investment vehicles] and other structured finance obligations, or if it had not succumbed to greed by increasing the amount of insurance written on this type of business," the lawsuit says.

The city accused UBS of failing to make the appropriate efforts to remarket the bonds. The remarketing failure has raised the city's interest rate on the bonds to 10.5% from 6.95%, because it now receives a lower interest rate from UBS on its swap and has to pay the bank bond rate of prime plus 1% per annum due to its standby bond purchase agreement.

Other cities are also taking action against bond insurers. Los Angeles Wednesday filed a suit against six bond insurers, accusing them of selling what became "worthless" insurance. Oakland city attorney John Russo told Reuters Friday he will file a similar suit.

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