On Monday, Ambac Financial Group (ABK) commuted $16.4 billion of exposure to collateralized debt obligations of asset-backed securities. 

This conversion agreement, which changes the existing debt to a less severe one, requires Ambac Assurance Corporation (“AAC”), the bond insurance unit of Ambac Financial, to pay $2.6 billion in cash and $2.0 billion in newly issued surplus notes. The notes will pay an annual interest rate of 5.1%, with maturity scheduled on Jun 7, 2020. However, the principal and interest payment will be subject to the prior approval of the Office of the Commissioner of Insurance (OCI) of the State of Wisconsin. 

Besides, Ambac announced certain non-collateralized debt obligations of asset-backed securities transactions worth approximately $1.4 billion were commuted for a cash payment of $96.5 million. 

Ambac also intends to convert certain other non-collateralized debt obligations of asset-backed securities exposures worth $1.5 billion for a maximum amount of approximately $115 million of cash plus $60 million of surplus notes of AAC. This conversion is expected within the next twelve months subject to certain conditions. 

Ambac’s decision to discontinue credit enhancement transactions in credit default swap or other derivative formats and terminating almost all its reinsurance contracts to streamline outstanding liabilities under reinsurance exposure will help it to return to profitability. This decision will also increase liquidity and earned premiums and improve the risk-based capital position. 

However, Ambac has suffered multiple rating downgrades since June 2008 that have adversely impacted its ability to generate new business. Moreover, the state of Wisconsin took control of some of the Ambac’s worst-hit assets (worth $64 billion) in March 2010. 

In March 2010, the rating agency Standard & Poor’s slashed the rating of AAC to “R” from “CC” following the rehabilitation announcement by OCI. To add to its woes, Moody’s Investors Service of Moody’s Corp. (MCO) slashed Ambac’s senior unsecured debt rating to “C” from “Ca”. However, AAC has a Caa2 rating under review with the possibility that Moody’s might upgrade the rating in the near future.
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