Ambac Posts $3.26B Quarterly Loss

Ambac Financial Group Inc. booked a massive loss Tuesday as mortgage-related troubles spread, but the bond insurer assured investors it remains a viable company even as its business slows.

"We just got too complex," Michael Callen, interim chief executive, said of his company's foray into bonds backed by risky mortgages. The fallout from that bet led to a $3.26 billion fourth-quarter loss.

The executive said Ambac is "evaluating strategic alternatives with a number of potential partners," as it seeks to maintain its "AAA" credit rating with two agencies and regain it after being downgraded by a third.

"We're talking to very credible parties and pools of capital," Callen said, but declined to be more specific.

Investors responded positively, sending Ambac shares surging $1.77, or 28.6 percent, to $7.97 Tuesday. The stock is still down 92 percent from its 12-month high of $96.10 set last May, after losing more than 70 percent last week.

"Callen is very much putting on an outward face that Ambac is in it for the long haul," said Donald Light, senior analyst at Celent. "Their actual situation is not noticeably worse than other major bond insurers, but that doesn't mean it's a good one."

For years the New York firm made a tidy living backing billions in municipal bonds that rarely defaulted, paying a steady dividend. The returns weren't spectacular, but there was little risk to the business.

When the housing market took off, and lenders starting issuing riskier mortgages, investment banks packaged them into complex bonds. For insurers such as Ambac and competitor MBIA Inc., the new bonds were an opportunity to generate outsize returns of their own.

But when the housing bubble burst and mortgage defaults spiked, the assets underlying the bonds lost value, increasing the likelihood of issuer default and claims on bond insurance.

Those concerns have brought the once rock-solid bond insurers to their collective knees. MBIA was forced last week to raise $1 billion to avoid a debilitating ratings downgrade.

Ambac wasn't so lucky _ it balked at shoring up its reserves, saying market rates were too unfavorable, and was promptly hit with a two-notch downgrade by Fitch Ratings to "AA."

The agencies want the insurers to have reserves sufficient to cover the expected increase in claims.

Ambac, which insures $550 billion in debt, said Tuesday it could pay $14.5 billion in claims, noting that it paid none on mortgage-backed bonds in 2007 and that the outlook for the current year is favorable.

"We don't expect more than $10 million" in claims in 2008, Chief Financial Officer Sean Leonard said on a conference call.

But the loss of the top-notch "AAA" rating could strip the insurer of its ability to drum up new business, particularly with municipalities. They need bond insurers to have that rating because it enables them to pay lower interest rates on bonds they issue.

Ambac's business slowed sharply in the fourth quarter, with net premiums written dropping 78 percent. Callen said he thinks Ambac can continue to write new insurance and that he is confident the company can strengthen its capital position to regain the "AAA" rating from Fitch.

Callen, who took over as interim CEO last week after the abrupt departure of Robert Genader, said his company was being "actively regulated" as it tries to recover the "AAA" rating. On Tuesday, the New York State Insurance Department said it was working with the bond insurance market to ensure the stability and availability of that insurance.

If Ambac isn't able to write new insurance, it will still generate premium revenue and be able to pay claims, a situation known as being in a state of "run-off," where an insurer slowly winds down its business. But Callen told investors Ambac had "banished" the word "run-off" from its offices.

Ambac's fourth-quarter loss included a write-down of $5.21 billion, or $33.14 per share, on the book value of certain financial instruments, called credit derivatives. These contracts help insure bond buyers against losses if the bond issuer defaults or the assets underlying the bond lose value.

That total included a charge of $1.11 billion, or $7.03 per share, that the company set aside because it expects to have to pay claims on defaults related to securities backed by risky subprime mortgages.

The company's operating loss reached $6.21 per share versus a profit of $1.88 per share last year. Analysts expected that result to be a loss of $3.50 per share, according to Thomson Financial.

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AP Business Writer Stephen Bernard contributed to this report.