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(Updates to add that Ambac may receive government funds within three months.)



) --

Ambac Financial Group


, unlike other financial companies, isn't in denial about the extent of its troubles -- it's just the opposite.

The bond insurer is upfront that it may have to file for bankruptcy in 2011. But perhaps investors ought to focus on more immediate problems, such as meeting Wisconsin insurance minimum capital and surplus requirements. Ambac's insurance operations are domiciled in that state.

Bond insurers are fighting for survival.


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isn't writing new bond coverage even though it has restructured itself.

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is still writing coverage, but it posted a third-quarter loss of $35 million.

In June, I identified Ambac's situation as "perilous." At the time, the company was trying to launch Everspan, a new bond insurer, that it hoped would regenerate business. Shortly afterward, frustrated with its inability to raise funding, Ambac abandoned the attempt. reported in June that Ambac wasn't in compliance with state capital and surplus requirements at Ambac Assurance and that it would have to submit a remediation plan.

Then, like now, immediate liquidity wasn't considered the issue. Unlike then, we can now make projections about liquidity running dry. The deadline for Ambac to file statutory financial statements for the insurance company with the Wisconsin Department of Insurance was yesterday. The filing will indicate that its capital and surplus position has deteriorated, according to the insurer's own statements.

When an insurer fails to meet a state insurance regulator's minimum requirements for capital and surplus, it usually is required to explain the circumstance and how it intends to remedy the situation. The company and regulator then agree on a plan for re-capitalization and a timeframe. If the business fails, the company can be placed under the supervision of the insurance regulator by court order until it meets the requirements or seeks an order to wind up operations.

In Ambac's case, Chief Executive Officer David Wallis said on the third-quarter earnings call that there is constant communication with Wisconsin's insurance regulator and that "the relationship continues to be excellent." He was unable to confirm that, when the statutory filing was made Monday, the insurance commissioner wouldn't place Ambac under supervision.

Jim Guidry, a spokesman for the Wisconsin Office of the Commissioner of Insurance, told on Monday that although the Ambac filing was still outstanding, the department was "unable to comment on any contemplated or ongoing action."

The second issue is liquidity. With a net reduction of cash and cash equivalents of $981 million to $150 million between the second and third quarters, that's a valid concern. Ambac has reported adequate liquidity in the short term at the holding company. The concern is more about the operating company.

With anticipated payments on insurance policies of $2.5 billion in the next 12 months and only $1.4 billion in investment income (including disposals) and premiums anticipated, there's a $1.1 billion gap that needs to be filled. The question is: Where can you raise cash without liquidating assets? Ambac is hoping to receive up to $400 million in a tax refund. The insurer expects to receive the money within 90 days.

Another problem is that loss reserves for residential mortgage backed securities include $1.9 billion of estimated remediation recoveries. Those are recoveries due to misstatements made on mortgage applications that were subsequently insured. That remediation amount increased by $738 million in the third quarter, according to Ambac. To date, though, the insurer has collected only $60 million. Chief Financial Officer Sean Leonard says Ambac is in discussions about reaching a global settlement regarding one transaction. To be sure, Ambac's calculations could fall short and, therefore, the loss provisions may be inadequate.

Ambac's stock, which is trading at 75 cents, will continue to be extremely volatile for the foreseeable future and, especially, until the Wisconsin matter is cleared.

Reported by Gavin Magor in Jupiter, Fla.

Gavin Magor joined Ratings in 2008, and is the senior analyst responsible for assigning financial strength ratings to health insurers and supporting other health care-related consumer products, including Medicare supplement insurance, long-term care insurance and elder care information. He conducts industry analysis in these areas. He has more than 20 years' international experience in credit risk management, commercial lending and analysis, working in the U.K., Sweden, Mexico, Brazil and the U.S. He holds a master's degree in business administration from The Open University in the U.K.