Ambac clears deck of $1.4 billion CDO-squared

Commuting means scrapping insurance contracts under mutually-agreeable terms. In the case of the CDO-squared, Citi received a final cash payment of $850 million from the beleaguered monoline.

The deal originally referenced AA-rated classes of CDOs of asset-backed securities, most of which have now been downgraded to below investment-grade, according to a statement released by Ambac.

As of March 31, the monoline had recorded approximately $1 billion of mark-to-market losses against the transaction, including a $789 million impairment loss. Thanks to the settlement, Ambac said, it would record a positive pre-tax adjustment of around $150 million to its aggregate mark-to-market position.

Michael Callen, Ambac’s chairman and chief executive, said it viewed the settlement as favourable, in light of “widely-circulated models that assumed a 100% write-off”.

“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,” he added.

Like rating agencies, banks and investors, monolines have been caught out by monumental losses in securitisations, including CDOs, linked to US subprime mortgage loans. With the majority having been stripped of their AAA ratings, Ambac and others are looking to reduce their exposure to the shipwrecked US subprime mortgage market by commutation and various other means.

On July 28, New York-based XL Capital Assurance announced it and Merrill Lynch had agreed to terminate financial guarantees on CDOs with a gross value of $3.74 billion. Merrill Lynch had carried the hedges at $1 billion on June 27, but accepted just $500 million to commute the contracts.

The settlement reflects the dire condition of monolines, which face persistent questions about their solvency. Prior to the crisis, dealers used bond insurers to remove billions of dollars of CDO exposures from their books – exposures which are fast returning as the creditworthiness of monolines falters.

See also: Merrill raises yet more capital after Q2 losses
Further monoline downgrades likely

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