More Pain for Ambac

The bond insurer's "crisis of confidence" continues with deeper-than-expected losses in the first quarter

Nearly everyone expected Ambac Financial Group's (ABK) first-quarter earnings to be bad, but few expected losses of this magnitude. The New York-based credit insurer reported a net loss of $1.66 billion, or $11.69 per share, due to writedowns on CDOs and mortgage-backed securities. Even excluding non-recurring items, Ambac lost $6.93 per share, well below the First Call estimate of a loss of $1.51.

It wasn’t just securities losses that did the company in. Premiums on credit insurance products fell 87% and new policy writing has come to a near standstill. "People expected the mark-to-market writedowns. They expected underwriting to be weak," said Standard & Poor's Equity Research analyst Cathy Seifert. "But no one expected an operating loss of $6.93 per share." (S&P, like BusinessWeek, is owned by McGraw-Hill Companies (MHP).)

Ambac shares, already down more than 90% from a 52-week high, skidded 43% to close at $3.46 on Apr. 23.

The results come on the heels of a traumatic three-month period for Ambac. In January, the company announced more than $5 billion in mark-to-market losses on credit derivatives. It spent the next two months battling to retain its AAA credit rating, vital to attracting new bond insurance business. In March, Ambac attracted $1.5 billion in new capital to cover losses, but the new writedowns could undermine the damage control.

"Last quarter was supposed to be a best guess [for writedowns] and they weren’t even close," said William Blair & Co. analyst Mark Lane.

Now, the company must now regain the trust of its customers. "We recognize we are working through a crisis of confidence," said Ambac CEO Michael A. Callen in its conference call. Part of that effort will include greater transparency, including the posting of outside analysts reports, no matter how dire the predictions, on the company’s website, as well as attempting to resolve issues in the auction rate securities market.

Ambac is also digging into some of its worst mortgage-related investments, including two from Bear Stearns (BSC) with default rates approaching 80%, to discover whether they were fraudulent.

Still, no one expects the turnaround to occur overnight. "We have to have to demonstrate a quarter or two of losses having been recognized and now under control and having plateaued," Callen said. "The way I look at it is the first of next year we’re back up and running, or there about."

During the conference call, Ambac said that it had kept the ratings agencies up to date on the losses and that the current quarter is within the stress tests. At least one agency, Standard & Poor's, said after the earnings announcement that it will leave Ambac's rating unchanged for now.

That may not be enough, however, to ensure the company’s viability. "The risk is that if they can't regain the confidence of the marketplace," says Seifert at S&P, "then it's game over."

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