Ambac Financial Group will pay Citigroup $850 million to settle one of its largest CDO exposures. This is for guaranteeing a CDO transaction worth $1.4 billion.

This will improve the excess capital position of its insurer subsidiary Ambac Assurance Corp.

Published reports said that with this announcement, Ambac's shares rose as much as 26% after the firm said it will record a gain of $150 million as a result of the contract.

In a release issued today, Ambac said that as of March 31, 2008, Ambac had recorded roughly $1.0 billion of mark-to-market losses, which includes an impairment loss of $789 million, against this deal.

As a result of the settlement, Ambac expects to record a positive pre-tax adjustment of approximately $150 million to its aggregate mark-to-market. In addition, the stress case losses in the rating agency capital models for this deal exceeded the bond insurer’s final payment and because of this, the settlement will result in an improved excess capital position for Ambac Assurance.

“The primary benefit of this agreement is that it eliminates uncertainty with respect to future losses related to this transaction," Michael Callen, chairman and CEO of Ambac, stated. "We view the final outcome as favorable in light of the numerous widely circulated models that assumed a 100% write off for this transaction. This settlement also confirms our view that transaction mark-to-market adjustments are not indicative of ultimate credit impairment.”

Callen added that this is an important milestone in the firm's efforts to work with counterparties as it evaluates settlement as well as other restructuring opportunities related to its CDO exposures.

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