Two Months Later, The Market Finally Fears an Ambac Bankruptcy

| About: Ambac Financial (AMBC)

At the heights of the stock market’s low-volume spring rally, Ambac Financial (ABK) soared 72% and the 105% on two consecutive days. ABK was up another 50% the next day before closing with a 28% loss. The upward surge was quite startling given ABK was pretty clear in its earnings report at the time about the risks of bankruptcy. The first of its 33 risk factors stated:

Ambac has insufficient capital to finance its debt service and operating expense requirements beyond the second quarter of 2011 and may need to seek bankruptcy protection.

It took crack analysts at JP Morgan to shake the market out of its celebration over a statement like this. These analysts pointedly stated that ABK is essentially “worthless,” and that essentially sent the stock down that third day after ABK reported earnings.

Yesterday, news circulated that some debt holders may attempt to jam ABK into a bankruptcy filing. This news came on the heels of another liquidity warning from ABK, posted near the top of a June 8th, 8-K SEC filing. It looks like a carbon copy of the last set of warnings:

While management believes that the Company will have sufficient liquidity to satisfy its needs through the second quarter of 2011, no guarantee can be given that it will be able to pay all of its operating expenses and debt service obligations thereafter, and its liquidity may run out prior to the second quarter of 2011. Further, prior to the second quarter of 2011, and as early as the second quarter of 2010, the Company may decide not to pay interest on its debt. The failure by the Company to pay interest or principal on its debt when due would result in an event of default, thereby permitting the debt holders to accelerate the maturity of the Company’s outstanding debt. As a result, the Company may consider, among other things, raising additional capital to the extent possible, a negotiated restructuring of its outstanding debt through a prepackaged bankruptcy proceeding or a bankruptcy without agreement concerning a plan of reorganization with major creditor groups. No assurance can be given that the Company will be successful in executing any or all of these strategies.”

Unlike the last warning, this announcement came during a time when market participants are back to worrying and debt has become a 4-letter word. So, instead of a celebratory 70-100% gain, ABK dropped 39% on the day.

Of course, I am simplifying a bit cause and effect to highlight how interpretation of the news can depend on the prevailing mood of the market. Also, despite the eye-popping percentage moves, ABK remains a “penny stock” that that traded close to $100/share just three years ago. At this point, trading in such a stock is bound to make little sense. But, hey, who said it had to make sense in the first place?

ABK seesaws on sentiment around potential bankruptcy

ABK seesaws on sentiment around potential bankruptcy

*Chart created using TeleChart

Be careful out there.

Disclosure: No positions