Nov. 5 (Bloomberg) -- Ambac Financial Group Inc., the bond insurer that lost 86 percent of its stock market value in the past year, posted a third-quarter loss as it set aside at least $3 billion to pay anticipated claims.

Ambac dropped as much as 26 percent in early New York trading after the company said its net loss widened to $2.43 billion, or $8.45 a share, from $360 million, or $3.53 a share, a year earlier. Excluding changes in the value of securities it holds and insures, Ambac said in statement today that its loss was $7.81 a share, compared with an average estimate for a loss of $1.09 from five analysts surveyed by Bloomberg.

Ambac's prospects are dimming as business grinds to a halt, plans to start a new municipal bond insurer stall, and writedowns the company had taken in past quarters continue to morph into actual cash claims. Moody's Investors Service, which stripped Ambac of its last Aaa ranking in June, placed the ratings back under review in September after raising its expectations for losses on mortgage securities the company guaranteed.

``The big issue for bond insurers is their ratings and I suspect Moody's is waiting to see earnings,'' said Jim Ryan, an analyst with Morningstar Inc. in Chicago. ``If the rating agencies pile on, that could create more problems.''

Ambac took a $2.7 billion charge to reflect a decline in the value of securities it had guaranteed using credit-default swaps. That type of mark-to-market loss, which doesn't always indicate an expected cash payment, this time forced the bond insurer to set aside about $2.5 billion to make good on those contracts, according to the statement. Ambac also took a charge of $607.7 million for expected claims on bonds backed by home equity loans.

Government Help

Ambac's market value has fallen to about $975 million from more than $9 billion at the start of 2007 just before the subprime mortgage market began to unravel. Ambac fell 88 cents to $2.52 at 7:18 a.m. in early New York Stock Exchange trading.

Several bond insurers, including Ambac and larger competitor MBIA Inc., are required to post collateral against investment contracts if their insurance units are downgraded. A decline in the value of securities backing those contracts may create a cash shortfall of more than $2 billion at Ambac's holding company, according to a Sept. 19 statement.

Michael Callen, who stepped down as Ambac's interim chief executive officer on Oct. 21, called on the credit rating companies to hold off on downgrades until a $700 billion government plan to stabilize the financial system is implemented. Ambac is pushing for federal help with its bond insurance portfolio, saying a Treasury backstop on some of the securities bond insurers have guaranteed would help restore confidence in the ability of the companies to meet all their obligations.

Market Share

The New York-based company, in an Oct. 28 letter to the Treasury, expanded on the idea by proposing an ``excess of loss portfolio guarantee program offered to entities that traditionally buy and hold credit risk.''

Chief Risk Officer David Wallis, 48, was named CEO last month, with Callen agreeing to stay on as chairman, as the company fights for survival.

Ambac had zero market share during the third quarter and the drought in business continued into October, according to data provided by Thomson Reuters. Assured Guaranty Ltd. and Warren Buffett's Berkshire Hathaway Assurance grabbing up most of the market, with Berkshire backing 44 percent of all new bonds insured by cities and states, and Assured guaranteeing 45 percent.

Ambac, MBIA and the rest of the industry have posted record losses after expanding from guarantees on municipal bonds that rarely default to insuring securities tied to mortgages that are now going delinquent. Ratings companies downgraded about $118 billion of prime-jumbo and Alt-A bonds in September following a record $200 billion of downgrades in August, according to an Oct. 3 report from JPMorgan Chase & Co.

Connie Lee

Five of seven bond insurers lost their top AAA ratings. As the insurers' ratings collapsed, cities and states saw the value of their bonds drop and banks that had purchased protection against a decline in the securities they held were forced to take writedowns.

Moody's put Ambac's insurance rating back under review on Sept. 18 because the company is ``meaningfully exposed to the risk of U.S. subprime mortgages and other residential mortgage products.''

The review prompted Ambac to reconsider its decision to bankroll Connie Lee. Ambac's contribution of $850 million of capital to the unit is being postponed because it may need the cash to terminate or post collateral for its guaranteed investment contracts, the company said in a Sept. 19 statement.

The fresh start would have allowed Ambac to compete for providing guarantees on debt issued by cities and states, a business it pioneered in 1971 before expanding into more untested securities such as collateralized debt obligations.

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

Last Updated: November 5, 2008 07:30 EST