Yesterday, Ambac Financial Group (Ambac) announced that its principal subsidiary Ambac Assurance Corporation (AAC), has established “a segregated account for certain of AAC's liabilities, primarily policies related to credit derivatives, residential mortgage-backed securities (RMBS) and other structured finance transactions” pursuant to the direction of the Wisconsin Office of the Commissioner of Insurance (OCI). The segregated account is “supported by a $2 billion secured note issued by AAC and an aggregate excess of loss reinsurance agreement provided by AAC.”

In connection with the establishment of the segregated account the OCI filed a petition to assume control of and to rehabilitate the segregated account and “received court approval to impose a temporary moratorium on further claim payments to Segregated Account policyholders pending approval of a plan of rehabilitation.” The policies that will not be transferred into the segregated account will remain in AAC and will not be directly impacted by the rehabilitation plan. Pursuant to Wisconsin law, a segregated account is treated as a separate insurer from the institution for purposes of rehabilitation. As a result, the rehabilitation of the segregated account does not require a rehabilitation of the institution as a whole.

Specifically the segregated account established by AAC will contain the following:

  • certain policies insuring or relating to credit default swaps;
  • all of its RMBS obligations;
  • certain other identified policies insuring troubled credits;
  • certain student loan policies; and
  • certain other contingent liabilities (including but not limited to all of AAC's liabilities as reinsurer under certain reinsurance agreements).

Ambac also noted that the “[c]ounterparties to credit default swaps insured by AAC representing a significant portion of the net notional amount outstanding as of December 31, 2009, have agreed to temporarily forebear from accelerating the obligations of AAC under such credit default swaps or asserting any claims against AAC or any affiliate of AAC based upon the segregated account rehabilitation proceedings.”

The OCI which has been closely observing the ACC’s financial stability since the onset of the financial crisis emphasized that it strongly believed that the actions taken were necessary to strengthen the institution’s financial position. Wisconsin Commissioner Dilweg noted that the OCI was “taking action to protect policyholders, including investors in thousands of state and local municipal bond issues and other public finance securities, who rely on AAC's guaranty," he also stated that a concrete plan for rehabilitation was in place and that the proposal would be reviewed in court over the coming weeks.

Ambac also announced that it reached a non-binding agreement “on the terms of a proposed settlement agreement with several counterparties to commute substantially all of its remaining collateralized debt obligations of asset-backed securities (CDOs of ABS).” Pursuant to the proposed settlement agreement AAC will pay $2.6 billion in cash and $2.0 billion of newly issued surplus notes of AAC. However, the terms of the proposed settlement agreement remain subject to OCI approval and may change prior to the close of the transaction.

Ambac's Chairman of the Board of Directors, Michael Callen, commented that "[i]n light of OCI's determination to take some sort of rehabilitative action with respect to Ambac Assurance, the Board has determined, after thoughtful and careful consideration, that compliance with the direction of OCI to establish the segregated account of Ambac Assurance and to consent to the terms of the proposed settlement agreement of our CDO of ABS portfolio is the best alternative available.”