Ambac Assurance Corp., the bond-insurance unit of Ambac Financial Group Inc., is handing over to its state regulator control of troubled contracts on securities made up of souring mortgages, totaling about $35 billion, that could potentially bleed the insurer dry and endanger its commitments to municipal bondholders.
As a result, the company's regulator, the Wisconsin Office of the Insurance Commissioner, will suspend payments totaling about $120 million for March to holders of these contracts. These policy holders include banks, pension funds, hedge funds and other insurance companies. As long as the regulator is overseeing these contracts, monthly payments beyond March are also suspended.
In 2009, Ambac paid out $1.4 billion in claims to policyholders, according to an annual filing with its regulator. These payments were primarily related to losses on securities made up of souring mortgage loans, according to people familiar with the matter.
An Ambac spokeswoman was unavailable for comment.
The commissioner's office will seek to unwind these insurance contracts that Ambac sold to financial firms but can't fully pay off without jeopardizing claims of other policyholders. These contracts being unwound were intended to protect investors mainly from losses on mortgage securities.
This is a "time out so we can put in place an orderly process for these policyholders to receive payments on their claims," said Sean Dilweg, Wisconsin's insurance regulator. "We found it appropriate to preserve resources to ensure a fair distribution among all the policy holders." The regulator assumed control over these troubled contracts, primarily made up of policies insuring principal and interest payments on mortgage securities, through a process called rehabilitation. It received the go-ahead Wednesday from a Wisconsin state court.
An executive who led the negotiations for Citigroup Inc. said in an emailed statement, "We are pleased to have a fair settlement of this extremely complex and difficult situation, and we are particularly appreciative of the creative and even-handed work of" the insurance regulator "in bringing the parties together."
Citigroup's exposure to Ambac, using a "fair value" estimate, is $4.5 billion, according to Citigroup's annual report. Citigroup has reserves of $5.5 billion for exposure to so-called monoline insurers, including Ambac, in the event they are unable to fulfill their commitments.
Ambac insures the interest and principal payments on bonds, committing to pay investors if a bond issuer defaults. Initially this business was tied to the stable municipal-bond market where it insured debt issued by city power authorities, state and local governments, and schools. But, in the past decade, Ambac moved into the more lucrative arena known as "structured finance." A big chunk of these were known as collateralized debt obligations, or CDOs, that pooled risky subprime bonds, whose value has deteriorated substantially. As of September 2009, Ambac had exposure to $48.7 billion in CDOs.
Ambac's U.S. municipal and state bond insurance book totaled about $230 billion, as of the third quarter. Its coverage of this book will be unaffected by the rehabilitation process that mainly concerns the structured finance business.
Financial firms, including investment and commercial banks, paid Ambac annual fees for bearing the risk in their debt securities. A reason the banks used these insurance contracts was to shield themselves from the impact of market-price fluctuations, so the banks didn't have to reflect such fluctuations in their earnings reports.
Ambac, which once boasted top triple-A credit ratings, said as recently as November that it could have problems paying off debt that comes due in 2011. Ambac Financial, the insurance unit's parent, also said it was considering strategies that include a prepackaged bankruptcy-court filing. The company recently delayed the filing of its annual report.
Before the financial crisis, Ambac was the second biggest bond insurer behind MBIA Inc. MBIA angered policyholders, including banks, holding its insurance on securities backed by subprime mortgage assets and commercial real estate loans when it split its businesses last year. The policyholders worried that the division of the company left too little backing for their policies. Four lawsuits against MBIA brought by financial firms, including banks, are still pending.