Ambac’s Capital Levels Concerning

Last week, Ambac Financial Group (ABK - Analyst Report) announced that its chief operating unit Ambac Assurance expects to report estimated impairment losses on credit derivatives of $4.9 million. This will be an increase of $1.6 billion during the quarter. The expected write downs on the credit derivatives portfolio is a result of falling values of underlying collateral within the collateralized debt obligations of asset-backed securities.

The unit will also incur about $800 million in statutory loss and loss expenses in the period. The statutory loss and loss expenses relate primarily to deterioration in Ambac Assurance’s second-lien and Alt-A mortgage-backed securities financial guarantee portfolios. The impairment loss is expected to reduce Ambac's statutory capital and surplus.

At the end of March, Ambac Assurance had $372.8 million in statutory capital and surplus. With $1.6 billion in extra impairments from the second quarter, the unit would have negative statutory capital and surplus of more than $1 billion.

Ambac Assurance has appealed to the Wisconsin State Insurance Commissioner to discharge a substantial part of its contingency reserves, which totaled $1.95 billion at the end of March. That would replenish the unit's statutory capital and surplus. However, there is uncertainty about the release of funds.

To conserve cash, Ambac intends to stop paying interest on its directly issued subordinated capital securities on Aug, 1. Ambac Assurance will stop paying monthly dividends on the unit's auction market preferred shares on Aug. 1.

Following Ambac’s potential loss announcement, S&P downgraded Ambac and its insurance unit to deeply speculative grade. The rating agency is concerned about the company’s deteriorating capital levels. The losses are expected to eat into Ambac’s capital, causing it to fall below the minimum requisite levels.

S&P cut Ambac Assurance multiple notches to CC from BBB. It also lowered the counterparty Ambac Financial’s credit rating to CC from BB. CC is the most speculative non-investment grade rating. Ratings of BB or lower are junk. The ratings were removed from review for a further downgrade and the outlook is negative.

Moody’s also made a similar move by downgrading Ambac Assurance Corp by five notches to Caa2, eight steps below investment grade and a deeply speculative rating. Moody's also cut Ambac Financial's ratings by three notches to Ca, ten steps below investment grade.

Last month, Ambac deferred the launch of Everspan Financial Guarantee Corp., a new bond insurance unit, as it was unable to garner sufficient capital.

Peer MBIA Inc. (MBI - Analyst Report) has also seen several rating downgrades losing its “triple A” rating, since the onset of sub-prime mortgage crisis.