Ambac Is Unlikely to File for Bankruptcy

Ambac looks like it's heading toward bankruptcy, but there are many reasons why it won't.
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NEW YORK (TheStreet) -- Ambac Financial Group (ABK) , the bond insurer whose most toxic assets were seized by an industry regulator last week, is unlikely to file for bankruptcy.

Ambac Assurance, or AAC, accounts for about 70% of Ambac Financial Group. Wisconsin's insurance regulator, called the OCI, took part of AAC and put together a plan to protect policyholders. The move averted the possibility of an involuntary bankruptcy filing.

The OCI, in essence, is making way for a fair and equitable distribution of claims as they arise, according to the OCI. Partial cash payments and interest-bearing notes issued to settle claims will allow for the eventual development of future claims to be given the same treatment of earlier ones.

The injunctive relief granted by the court prevents action from being taken against Ambac Assurance for those claims. Any early termination claims would have precipitated the downfall of the company and almost certainly the group. (The OCI was unable to clarify if it had the latitude to let Ambac Assurance operate if Ambac Financial filed for bankruptcy.)

Ambac Financial now has time to weigh its options, one of which is to be restructured under a prepackaged Chapter 11 bankruptcy. Many stockholders say the company would have little to gain as the OCI already segregated the bad debt.

Relief provided from the OCI ensures two things will happen.

First, AAC's cash drain will slow. That's because it won't be making as many payments, yet it will still receive income from investments as well as some premium income. (Premiums must be paid or policies will be canceled.)

Second, AAC has to pay $2.6 billion in cash to settle $16.7 billion of collateralized debt obligations of asset-backed securities settlements. The only other major cash flow will be the $2 billion in funding guaranteed by the general account of AAC to capitalize the separate account (the toxic assets).

The plan is to prevent investments from being sold to meet payment demands. Still, those investments could fall further in value.

The elephant in the room is the bondholder.

There's a possibility the company will negotiate a prepackaged bankruptcy with bondholders. If so, Ambac Financial could move forward with a clean slate.

Any prepackaged bankruptcy would require the cooperation of the OCI. If the OCI seized the rest of Ambac Assurance, the remaining group would be completely exposed, making bankruptcy inevitable -- probably Chapter 7.

That's why bondholders are unlikely to make demands that would push the insurer into Chapter 11 protection. Unless bondholders have credit default swaps as insurance.

An alternative, besides doing nothing, is that bondholders might take some ownership of Ambac in exchange for debt.

All of those actions, including the probability of a stock split to adhere to trading regulations, would affect shareholders. Any debt for equity or reverse split would likely dilute the value of the new shares.

Ambac hasn't indicated it would willingly hurt stockholders. That's why, without bondholder pressure, Ambac is unlikely to file even a prepackaged bankruptcy at this time.

If bondholders could be persuaded to swap debt for equity, without a bankruptcy filing, a leaner Ambac could emerge. In time, it could become an active municipal-bond insurer again.

Investors dumped the stock last week, leaving the shares trading at about 50 cents. That could provide enormous opportunities for speculators. After all, Ambac has yet to file its 2009 financial results.

-- Reported by Gavin Magor in Jupiter, Fla.

Gavin Magor is the senior analyst responsible for assigning financial-strength ratings to insurance companies. He conducts industry analysis and supports consumer products. Magor has more than 22 years of international experience in operations and credit-risk management, commercial lending and analysis. His experience includes international assignments in Sweden, Mexico, Brazil and the U.S. He holds a master's degree in business administration from The Open University in the U.K.