Ambac Sold Insurance to Itself on Risky Bonds

Ambac sold itself insurance on residential mortgage-back securities, piling on risk.
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NEW YORK (TheStreet) -- Ambac Financial Group (ABK) , even as it teetered on the brink of bankruptcy, invested in at least $2.5 billion of residential mortgage-backed securities, piling on risk during the worst credit bubble in U.S. history.

Making matters worse, Ambac insured a third of that amount. The full sum is now insured in a segregated account seized by Wisconsin's insurance regulator, or OCI, whose goal is to keep the company from falling into bankruptcy. The OCI is responsible for making good on Ambac's investments if the bonds fail to perform.

Ambac, which is struggling to remain solvent after it was forced to pay billions of dollars in payouts to companies that bought bond insurance, is under threat of a delisting from the New York Stock Exchange. Shares of the company, which has a junk rating, have traded as low as 51 cents and shot up past $3 in the past week, only to fall to less than $2 in recent days.

Amabc, which along with

MBIA

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are among the biggest bond insurers in America, spent $329 million on the debt it insured, now recorded at $332 million as an asset on its books. According to Ambac spokesman Peter Poillon, it was sort of a so-called deep-value play that could pay off with outsized returns. Investors viewed the bonds dimly, though Ambac thought it had an advantage, as it knew the performance of the underlying accounts. Ambac got the securities at a 44% discount.

Poillon said Ambac wasn't in double jeopardy because, if the company had to pay out on a default, it would be paying itself. Still, the value of the bond would deteriorate, potentially producing a loss for Ambac.

Thanks to the OCI, Ambac has managed to find a way to remove the liability and, at the same time, negotiate insurance coverage for its investment. Ambac would receive 25 cents on the dollar in cash and the balance as a note, just like any other bondholder, in the event of a default.

A call requesting a comment from the OCI wasn't returned.

-- 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.