Insurance holding company Ambac Financial Group reported a net loss in the second quarter, despite big gains in the value of its insured derivatives, and warned that it may be unable to pay its debts in a year.

The statutory capital of its bond insurance subsidiary increased tenfold during the same period. Ambac Financial posted a net loss of $57.6 million from April to June. The company blamed the decline primarily on deterioration within its structured finance portfolio, which was offset by a positive change in the value of credit derivatives, according to an earnings statement released Monday.

The second-quarter net loss compares favorably to the $2.4 billion loss reported in the same quarter one year ago. New premiums earned in the quarter were $167 million, compared with $178 million in the second quarter of 2009.

The holding company posted a $202 million gain in the fair value of derivatives, and $66 million from net investment gains.

Ambac Financial has been warning since November that it may face bankruptcy as early as 2011. Monday’s statement said it has “insufficient capital to finance its debt service and operating expense requirements beyond the second quarter of 2011.”

Its deficit to shareholders was $2.1 billion at the end of the second quarter, the report shows. Also, cash, short-term securities and bonds at the holding company amounted to $76 million at the end of the second quarter. That compares with annual debt service costs of about $87 million.

In early July the New York Stock Exchange put the company on de-listing watch for failing to maintain a minimum share value of $1.00.

Ambac Financial stock closed Monday at $0.91, up 3.41% on the day. Once the earnings statement was released, after-hours trading pushed the stock price down more than 15%.

Its prime subsidiary is struggling insurer Ambac Assurance Corp., a former leader in the industry that was forced to stop writing new policies after exposure to mortgage-related products hurt its balance sheet and impaired its credit rating. Ambac Assurance has not written new policies since June 2008.

The insurer increased its statutory surplus to $1.5 billion in the second quarter, up from $160 million at the end of March.

The gain was driven primarily by a major settlement on June 7, in which Ambac paid counterparties to commute, or tear up, a variety of insurance claims based on complex mortgage assets — CDOs of ABS. The settlement was completed at the behest of Ambac Assurance’s regulator, the Wisconsin Office of the Commissioner of Insurance.

Wisconsin state documents suggest Ambac paid 14 major banks $2.6 billion in cash and $2 billion in surplus notes to repurchase the contracts, which had a face value of $16.4 billion.
Commissioner Sean Dilweg in late March took $35 billion of Ambac Assurance’s most toxic holdings and placed them into a segregated account to be administered by his office.

Ambac Assurance now has “no remaining statutory impairments on its credit derivative portfolio,” the earnings statement said.

Ambac Assurance’s total claims-paying resources amounted to $8.5 billion as of June 30, down from $10.8 billion in the prior quarter. The decrease results from net cash outflows during the quarter.

In mid-June, Moody’s Investors Service said the possible bankruptcy of Ambac Financial is unlikely to affect policyholders of Ambac Assurance.

Meanwhile, in other bond insurer news, insurance holding company MBIA posted a second quarter net income of $1.3 billion.

MBIA on Monday reported net income of $1.3 billion in the second quarter, but the huge advance reflects mark-to-market gains on insured credit derivatives rather than new business.

An accounting quirk explained most of the second-quarter gain: contracts with MBIA insurance are worth less because MBIA’s own credit is worse; therefore, the value of its liabilities decreases, which in turn increases the value of its assets relative to liabilities.

Reflecting on a similar gain for the fourth quarter of last year, MBIA president and chief financial officer Chuck Chaplin in March said: “As we’ve reported for many quarters now, this gain is no cause for celebration, and when that same item swings to loss there will be no cause for alarm.”

Excluding the gain from derivatives and similar products, pre-tax income was $14 million, the second-quarter statement said. MBIA said that measure “presents an additional view” of its quarterly performance.

Total premiums earned in the quarter, including scheduled and refunding premiums, were $156 million.

MBIA is the parent of structured finance insurer MBIA Insurance Corp. and municipal bond insurer National Public Finance Guarantee Corp. The company’s February 2009 decision to segregate those two portfolios resulted in a series of lawsuits. Neither subsidiary has written new policies since 2008, and business is unlikely to resume until the ongoing litigation is resolved.

MBIA Insurance, which posted pre-tax income totaling $1.8 billion in the quarter, paid $421 million in net claims on second-lien residential mortgage exposures from April to June. The company noted that such claims “have been trending downwards each quarter since peaking at $636 million in the second quarter of 2009.”

The structured finance insurer held statutory capital of $3.3 billion and claims-paying resources of $5.5 billion, figures the parent company said would be adequate to pay anticipated claims.

In addition to the suits against it, MBIA has been involved for more than a year in a series of lawsuits to recover billions of dollars from a number of financial institutions that allegedly misled the insurer into guaranteeing assets that turned toxic.

MBIA believes the “ineligible” loans must be repurchased or replaced. In Monday’s earnings statement, it increased its expected recoveries from these lawsuits to $2.1 billion from the $1.9 billion expected at the end of the previous quarter.

“More market participants are recognizing that many of the loans in these securitizations should never have been in them in the first place, and that the seller/servicers must repurchase them,” Chaplin said in the earnings statement.

MBIA also announced that after the second quarter ended, its structured finance insurer paid $72 million to commute, or tear up, $4.4 billion of risky insured exposures held by an unnamed counterparty.

In addition, the structured finance insurer entered into a settlement with unnamed sponsors of mortgage loan securitizations. Under the agreement, it received an undisclosed amount of money for resolving a dispute “relating to its representation and warranty claims against the sponsor.”

Chaplin noted the company’s exposure to complex, synthetic products known as CDO2 were reduced by about 50% in the quarter.

“The net incurred loss on insured exposures demonstrates that credit stress continues to be a reality, but the volatility of losses appears to be declining,” Chaplin said.

In terms of MBIA's municipal business, National’s public finance portfolio earned $119 million in the quarter, a 10% decline from the revenue earned in the same period in 2009. The investment-grade insurer — which continues to maintain the largest insured bond portfolio in the industry — had statutory capital of $2.2 billion and claims-paying resources of $5.5 billion, the second-quarter earning statement shows.

Company stock closed Monday at $9.20, up 3.72% on the day. In light of the earnings statement, after-hours trading lifted that price another 8%.

In the month before the release, stock jumped almost 40%, in part due to the July 12 disclosure that Morningstar’s fund manager of the decade, Bruce Berkowitz, had purchased an 11.1% stake in the company.

A conference call for investors will be held Tuesday morning at 8:00 a.m. Eastern Daylight Time.

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