Ambac sees bankruptcy ahead

November 1, 2010, 7:47 PM UTC
Fortune

A signal moment of the financial meltdown came a step closer to reality Monday.

Bond insurer Ambac failed to make a scheduled $2.8 million interest payment on some debt and warned that it expects to be in bankruptcy by year-end, one way or another.



Not exactly a cliffhanger

New York-based Ambac said it decided not to make a scheduled payment on $75 million of 7.5% debentures due 2023. If the firm doesn’t make the payment within 30 days, it could be in default on the notes and could face acceleration of that debt’s maturity.

Bankruptcy talk is nothing new for Ambac, which warned around this time last year that it could run out of funds in 2011. The firm’s fate was further solidified in August, when Ambac said for the first time it was working on a prepackaged bankruptcy with creditors.

Ambac has $1.6 billion in outstanding debt and has been trying to restructure those obligations to reduce the drain on its cash position. The firm made a mint writing insurance for Wall Street on bonds and related derivatives, such as collateralized debt obligations, during the past decade.

But like so many others, Ambac found the profits were illusory when the tide turned. What’s more, the firm soon found it didn’t hold sufficient reserves to make good on claims when they came due.

Wisconsin’s insurance commissioner put Ambac’s credit derivatives unit into rehabilitation in March, leaving the firm to run off its municipal bond portfolio. Ambac hasn’t been writing new business since its credit rating was downgraded following the collapse of the housing bubble.

Ambac said it is trying to arrive at a deal with creditors that will result in a prepackaged bankruptcy filing, one in which lenders sign off in advance on a plan deciding how much they will receive in exchange for surrendering their current claims.

But if it can’t reach agreement with the creditors, Ambac said it expects to file for Chapter 11 on its own by year-end.

The company said one complicating factor is that while creditors will be expected to convert their debt claims to stock ownership in a reorganization, the timing of their debt purchases could knock the struts out from under the tax shelter the company has erected out of its massive postbubble losses.

Earlier this year, the Company entered into a Tax Benefit Preservation Plan to reduce the risk of an ownership change resulting from the trading of the Company’s stock.  Nevertheless, if the Company files for bankruptcy protection, stock issued to the Company’s debt holders in connection with a reorganization could trigger an ownership change if a significant portion of the debt being exchanged had been held by such debt holders for less than 18 months prior to the filing for bankruptcy.

Accordingly, extensive buying of the Company’s debentures prior to a bankruptcy filing by persons or institutions who could hold 5% or more of the Company’s stock following a bankruptcy reorganization could substantially limit the Company’s ability to use its NOLs in the future. 

Ambac stock, which has already lost all but a sliver of the value it held during the good old bad old days, was down 38% Monday at 51 cents.