Jan. 22 (Bloomberg) -- Ambac Financial Group Inc., the first bond insurer to lose its AAA credit rating because of subprime mortgages, is considering ``strategic alternatives'' after posting its biggest-ever loss. The shares jumped 29 percent on optimism the company may be sold.

The second-largest bond insurer posted a fourth-quarter net loss of $3.26 billion, or $31.85 a share, after writing down the value of credit-derivatives tied to loans made to homeowners with poor credit by $5.21 billion, according to a statement by the company today.

New York-based Ambac, which replaced its chief executive officer and scrapped a $1 billion equity sale last week after the shares dropped 71 percent, said stockholders and ratings companies are ``underestimating'' its ability to weather a decline in the value of mortgage securities. Fitch Ratings cut Ambac to AA from AAA, casting doubt on the company's guarantees on $556 billion of municipal and structured finance debt.

``They can't issue equity and they can't issue debt,'' said Robert Haines, an analyst at bond research firm CreditSights Inc. in New York. ``The new CEO might be prepping the company for a potential sale.''

Michael Callen, who became interim CEO after Robert Genader left, told analysts on a conference call that the company has no plans to stop writing new insurance, a process known as going into ``run-off.''

``There are too many viable alternatives in front of us,'' Callen said. Ambac is ``talking to credible parties and pools of capital,'' he said, without providing more details.

Hobbled by Expansion

Ambac shares rose $1.77 to $7.97 in New York Stock Exchange composite trading after earlier reaching $9.41. The stock has tumbled 91 percent in the past year, shaving $8.8 billion from the company's market capitalization. MBIA Inc., the largest bond guarantor, rose $3.98, or 47 percent, to $12.53.

The AAA rated bond insurers place their stamp on $2.4 trillion of debt. Losing those rankings may cost borrowers and investors as much as $200 billion, according to data compiled by Bloomberg. The industry guaranteed $127 billion of collateralized debt obligations linked to subprime mortgages that have plunged in value as defaults by subprime borrowers soar to records.

Ambac, which pioneered municipal bond insurance in 1971, has been hobbled by its expansion into CDOs, which package pools of debt and slice them into pieces with varying ratings. The CDO declines forced Ambac and others to reduce the value of contracts designed to protect CDO holders from default. Ambac said most of the writedowns aren't necessarily permanent losses and it hasn't paid any claims on its CDO portfolio.

`Too Complex'

``However safe we consider them internally, they just got too complex,'' Callen said.

Ambac recorded an impairment on more than $1 billion of CDOs, indicating it probably will record permanent losses. While the impairments ``blemished'' the company's guarantee in the eyes of some investors, the company's likely losses on CDOs are lower than those being estimated by analysts, Callen said.

``We have to believe that these marks serve as some rough proxy of future losses,'' CreditSights' Haines wrote in a report. Even if some of those writedowns ``eventually reverse, it is clear that losses are going to skyrocket,'' Haines said.

Ambac on Jan. 16 slashed its dividend 67 percent and said it would sell stock or equity-linked notes to bolster its capital, in part to meet Fitch's demand to raise $1 billion by the end of January. Two days later it scrapped the share sale.

The plan provoked a boardroom dispute that led to the departure of Genader, who disagreed with the capital raising, according to the company's regulatory filings.

Annual Loss

Before 2007, Ambac had reported profit increases every year for the past decade.

``In retrospect, insurers wish they'd never heard the term structured finance, much less written the business,'' said Donald Light, an insurance analyst at Celent, a consulting firm in Boston.

The fourth-quarter loss took the 2007 deficit to $3.23 billion, the company's first ever annual loss. Ambac on Jan. 16 forecast a fourth-quarter net loss of about $32.83 a share. The company reported an operating loss, excluding writedowns on contracts to guarantee subprime securities, of $6.21 per share.

Credit-default swaps on Ambac dropped 3.5 percentage points to 24.5 percent upfront and 5 percent a year today, prices from CMA Datavision in London show. The swaps had soared to 32 percent upfront and 5 percent a year.

Collateral Requirements

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

Ambac's investment management business requires the company to post collateral if its credit ratings are downgraded, Sean Leonard, Ambac's chief financial officer, said on the call. The largest collateral requirements are on investment agreements that Ambac has with borrowers, including municipalities, Leonard said.

A downgrade to AA- would require the company to post collateral of $2.2 billion. A cut to A+ could trigger a $5 billion collateral call and a reduction to BBB would result in the company needing to post $7 billion collateral, Leonard said.

Moody's Investors Service and Standard & Poor's, the two largest ratings companies, are reviewing Ambac's ratings for a possible reduction. Moody's said last week it may also cut the insurance ratings of Armonk, New York-based MBIA.

``The whole focus is back to AAA and an affirmation from the other rating agencies,'' Callen said on the conference call.

To contact the reporter on this story: Christine Richard in New York at crichard5@bloomberg.net

Last Updated: January 22, 2008 16:58 EST