Ambac: CDS Triggered?

| About: Ambac Financial (AMBC)

Yesterday news on Ambac hit the tape (NYSE:AP):

Bond insurer Ambac Financial Group said again that it may seek bankruptcy protection after state regulators took control of some of its most troubled assets.

The news Thursday sent the company's already devalued stock into a tailspin.

The Wisconsin insurance commissioner on Wednesday ordered Ambac's main operating subsidiary, Ambac Assurance Corp., which is based in that state, to set up a segregated account for policies related to risky structured finance transactions. Those include the credit default swaps and residential mortgage-backed securities held by major Wall Street banks that helped to accelerate the national financial crisis.

Commissioner Sean Dilweg is seeking to take control of the segregated account, and received court approval to temporarily halt any payments on claims on those policies. Ambac was paying $120 million a month in claims on the policies, and shelled out about $1.4 billion for them in 2009. In an interview, Dilweg said this week's action was in part taken to avoid the March payments.

All told, the assets moved to the segregated account add up to about $63 billion. A small amount of policies backed by student loans remain in the general account but will move to the segregated account after they are assessed, he said.

The commissioner said he has a plan to address policy claims and other liabilities in the segregated account, which will go before a special court for approval. After the moratorium period on payments is passed, it is expected that policyholders will receive part of their claims in cash and the remaining percentage in deferred payment obligation. There is no time frame for working out the segregated account. Determining the amount that will be distributed in cash and deferred obligations will be part of the process in the coming months, Dilweg said.

Based on these actions, a vote was taken today which determined there was a bankruptcy credit event at Ambac Assurance (all 15 parties voted yes).

The next step is an auction in order to determine the value of the obligations so that contracts may be settled.

The problem here is that it is not AAC (Ambac Assurance) that will miss the payments, it is the segregated account. From the press release:

Prior to approval of the plan of rehabilitation, claims in respect of segregated account liabilities will not be paid.

Importantly, the municipal book of business was not put into the segregated account. These actions may help buy the company some time to recover. But, with this in mind, ABK stated in an 8k yesterday that it may file a prepack bankruptcy, or traditional bankruptcy filing.

Bottom line, this is going to be a messy situation.

Disclosure: No positions