Ambac's Rally More Like Recovery

NEW YORK ( TheStreet) -- Ambac Financial Group's ( ABK) outsize third-quarter profit may look like an example of a pendulum swinging back but that's not entirely the case. And while the rally in the stock makes for some impressive headlines, it's really just returning the volatile shares to where they were a few sessions ago.

Yes, both the latest quarter and the year-ago results were heavily impacted by changes in the value of the company's credit derivatives portfolio, but the gain this year and the charge last year aren't really representative of two sides of the same coin.

Before Wednesday's opening bell, the New York-based provider of financial guaranty company reported earnings of $2.19 billion, or $7.58 a share, for the three months ended September 30. Included in the results is a massive gain of $2.13 billion from the change in the fair value of its credit derivatives portfolio. This gain was comprised of $2.87 billion in unrealized gains, offset by realized losses of $732.9 million in the quarter. Reinsurance cancellations with three counterparties were also a contributor in the latest quarter, adding $303 million to net income.

This performance is stacked up against the same quarter last year when Ambac's results were overwhelmed by mark-to-market adjustments of the negative variety. It posted a loss of $2.43 billion, or $8.45 a share, in the comparable period in 2008, weighed down by a fair value adjustment charge on the credit derivatives portfolio of $2.71 billion.

The stock is seeing heavy buying interest in early afternoon action, soaring nearly 39% to $1.54 a share, and it's bringing similar companies along for the ride, including MBIA Inc. ( MBI), up 11.2% to $4.57; Radian Group ( RDN), rising 11.3% to $6.59; and Triad Guaranty ( TGIC), advancing 14.6% to 80 cents.

Volume in Ambac shares reached 75.8 million, more than three times the issue's three-month daily average churn of 21.4 million, and its highest level since Sept. 22.

Still Ambac said its gain in the latest quarter was a product of the impact of widening credit spreads on its main unit, Ambac Assurance Corp. The widening of the credit spreads is an indication that investors are increasingly nervous about the issuer's ability to pay back its debt, but in this case, they also reduced the mark-to-market liabilities of the bond insurer, causing most of the unrealized gain.

The $2.71 billion charge in the year-ago period was mainly related to an increase in estimated future losses from the company's portfolio of high-grade collateralized debt obligations, or CDOs. It broke down to realized losses of $837.9 million -- the product of an $850 million payment to Citigroup ( C) to terminate a $1.4 billion CDO obiligation offset by $15.3 million in premium payments -- and unrealized losses of $1.87 billion because of lower values on reference obligations across all asset classes as well as internal ratings downgrades of the CDO portion of the company's ABS, or asset-backed securities, portfolio.

The company itself projected tempered optimism in its press release, saying attributing the GAAP results to changes in risk perception rather than some stroke of operational genius with David Wallis, Ambac's CEO and president, expressing optimism about its ongoing remediation efforts.

"We continue to make progress in de-risking the balance sheet via negotiated reinsurance buy-backs, CDO of ABS commutations, settlements related to defaulted RMBS residential mortgage-backed securities transactions as well as expanded analysis of expected recoveries relating to RMBS representation and warranty breaches," Wallis said in the statement.

As for actual operating metrics, Ambac said its net premiums earned fell 16% in the quarter to $238.4 million from $282.3 million a year earlier, while net realized investment gains in the company's financial guarantee portfolio swelled to $91.2 million in the quarter from $51.9 million last year. The company did see an improvement in loss and loss expenses for the quarter, going to $459.2 million from $607.7 million a year ago but net claims paid totaled $315.1 million in the quarter from $189.2 million last year, with most of the payouts related to RMBS transactions.

As of Sept. 30, Ambac's loss and loss expense reserves for all RMBS insurance exposures was a hefty $2.66 billion.

The surge in Ambac shares Wednesday follows a couple of weeks of weakness in the stock as it had been trading above $1.50 as recently as mid-October. The selling pushed the stock to a near-term low of $1 in intra-day trading last week but it resisted breaking below a buck. On that basis, the rally appears to be more a product of relief than any fundamental change in the company's prospects evident in the numbers. Like most of the market, the stock is up significantly since its foray down to 35 cents on March 9. But it's still off more than 60% in the past 52 weeks, and has been tracking lower since August.

Just as with its descent, the level and speed of recovery in the housing market -- the biggest influence on all those acronyms -- likely remains the most meaningful factor for both the long- and short-term outlook for the stock.

-- Written by Michael Baron in New York.

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