Bloomberg News

Ambac Judge Rules Against Mortgage Bond Investors (Update2)

May 26, 2010

Ambac Financial Group Inc. (ABKFQ:US) clients who purchased protection on residential mortgage-backed securities lost a court bid to halt implementation of a Wisconsin regulator’s plan to wind down the insurer.

Lafayette County Circuit Judge William Johnston made the ruling in state court in Darlington, Wisconsin, according to a statement late yesterday from Insurance Commissioner Sean Dilweg’s office.

Finding a compromise with a group of banks, including Deutsche Bank AG (DBK) and Royal Bank of Scotland Group Plc, was in the financial interest of Ambac and policyholders, and failure to do so may escalate claims by more than $8 billion, according to Dilweg’s statement.

“The steps we’re taking are aimed at avoiding billions of dollars of losses, and will provide the best way toward a durable solution for all policyholders,” Dilweg said in the statement. “There are very real and dramatic risks, if the orderly process we are pursuing is not preserved.”

Ambac rose 1 cents to 92 cents at 4:04 p.m. In New York Stock Exchange composite trading. The stock, which reached a high of $96.08 in May 2007, has advanced about 15 percent since March 25, when Dilweg announced his plan to restructure the insurer. A call to Ambac spokesman Peter Poillon wasn’t immediately returned.

Surplus Notes

Investors objected to Dilweg’s plan to create a segregated account for their policies that would pay them 25 cents on the dollar in cash for their claims, in addition to surplus notes that may be redeemed later if Ambac has sufficient funds. Critics of Dilweg’s plan said it favored banks that purchased protection separately for collateralized debt obligations.

Johnston dismissed a motion to enjoin Wisconsin-regulated Ambac Assurance Corp. and the bank group from proceeding with a so-called commutation of guarantees on $16.5 billion of securities backed by mortgages. Certain Ambac-insured bondholders challenged the deal saying it was unfair to all policyholders.

Ambac, the second-largest bond insurer before the onset of the credit crisis, was stripped of its AAA credit ratings (ABK:US) in 2008 after losses on securities backed by mortgages surged. In March, Dilweg announced he was splitting Ambac’s insurance unit in two in order to segregate policies on which the bond insurer is expected to pay claims.

Under the plan, New York-based Ambac was required to halt payments on $35 billion of the segregated policies until a rehabilitation plan for the policies is approved. Wisconsin regulators also announced that Ambac and a group of banks were working on an agreement to commute $16.5 billion of guarantees on collateralized debt obligations or CDOs backed by asset- backed securities, or so-called ABS CDOs, as a way to boost the bond insurer’s capital.

Settling for Less

The so-called commutation agreement would give banks between 35.8 percent and 54.4 percent of projected claims on the CDOs, according to BlackRock Solutions, which was hired by Ambac and Wisconsin regulators to value the guarantees on the 18 CDO. BlackRock estimated claims on the CDOs were valued at between $7.7 billion and $8.7 billion.

The guarantees were written in the form of credit-default swaps through Ambac Credit Products LLC. Ambac’s insurance unit, which is prohibited from entering into credit-default swaps, insured the swap obligations of Ambac Credit Products.

Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

‘Major Discount’

“Settling the growing, volatile ABS CDO exposures at a major discount inures to the benefit of all other policyholders,” Wisconsin regulators said in a May 20 brief filed in Dane County Circuit Court.

Policyholders seeking to block the bank deal include Freddie Mac, and hedge funds Aurelius Capital Management and Fir Tree Partners, which all hold Ambac-guaranteed residential mortgage-backed securities, and Eaton Vance Corp. which holds Ambac-insured Las Vegas Monorail Co. municipal bonds.

“The scant available information regarding the proposed CDS Settlement also creates fundamental questions as to whether the payment of $2.6 billion in cash, plus an additional $2 billion in surplus notes, would afford the CDS Banks more favorable treatment than Ambac’s policyholders are likely to receive,” Freddie Mac said in an a May 24 brief filed with the court.

To contact the reporters on this story: Christine Richard in New York at; Andrew Frye in New York at

To contact the editor responsible for this story: Alan Goldstein at; Dan Kraut at

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