The exposure of the financial guaranty industry to the securitization of a pool of debt obligations CDOs, generally corporate debt – as we all know by now ; became active since fiscal ’97. However, the acceleration of this activity into classes of securities with various levels of exposure to the underlying credit risk – picked up significantly in the last several years.
Since then, the risk written by the financial guarantors of these financial contracts (CDOs), shifted from mid to low investment grade towards higher rated exposures, mostly Aaa – reflecting a clearer specialization of market participants, or at least so they thought.
Ambac Financial Group, Inc. (ABK) – as an earlier entrant and active participant of the CDO market, starting since fiscal ’98 ; has been largely exposed to lower rated tranches as a result of their initial focus on cash CDOs. As a result, today – the co. announced that it has settled one of its largest CDO exposures, AA Bespoke, in exchange for a final cash payment of $850 million to its sole counterparty.
AA Bespoke is a $1.4 billion transaction that originally comprised AA rated CDO of ABS tranches, most of which have been downgraded to below investment grade since the inception of the transaction.
As of March 31, 2008, Ambac had recorded approximately $1.0 billion of mark-to-market losses, including an impairment loss of $789 million, against this transaction. Based on this settlement, Ambac expects to record a positive pre-tax adjustment of approximately $150 million to its aggregate mark-to-market.
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 is an important milestone in our efforts to work with counterparties as we evaluate settlement as well as other restructuring opportunities related to our CDO exposures.
The difficult credit environment, particularly since last year – revealed a damaging combination of historically high overall default rates, lowest recovery rates and a relatively large number of defaults by large debt issuers. These events and total lack of responsible actions from all parties involved – has affected in a major way both the direct investors in corporate bonds as well as CDO holders.