Ambac expects losses of 81.8% of underlying collateral

Shares of Ambac plunged over 40% to an intraday low of $3.08 as Lawyers Scrutinize Contracts On 17 Transactions.

Bond insurer Ambac Financial Group Inc. (ABK) has hired legal and forensic experts to examine 17 of its financial guarantee transactions covering residential mortgage-backed securities as performance deteriorates.

During its first quarter earnings conference call Wednesday, David Wallis, Ambac's chief risk officer, said the company is examining transactions that have performed much worse than expected.

Wallis suggested that one prime candidate for legal scrutiny is a deal with Bear Stearns Co. (BSC) it closed in April 2007. Another is a transaction with First Franklin.

Ambac originally projected that losses on the underlying collateral of the Bear Stearns transaction would be between 10% and 12%, but now expects losses at 81.8% of underlying collateral, a transaction that has seen an unexpectedly " rapid escalation of losses," and represents an outsized percentage of the insurer's expected credit impairment, Wallis said.

Some of the factors the company will examine include loan-level document review and a review of legal documents "focusing on representations and warranties," Wallis said. "Hypotheses are being built which involve fraudulent activity in various guises."

In recent months, both Security Capital Assurance (SCA) and FGIC Corp. have sued bank partners to cancel some financial guarantee contracts based on problems with the original agreements.

Credit-default swaps tied to the insurance units at Ambac and MBIA Inc. soared, suggesting investors are losing confidence in the ability of the companies to meet their obligations after bad bets on mortgage securities led to $3.1 billion in charges at Ambac.

The earnings report from New York-based Ambac also raised fresh concern that the world's two biggest bond insurers may face crippling ratings downgrades that would cast doubt on $1.2 trillion in securities they guarantee.

"They should have been cut and they weren't cut last fall, and that's part of the problem we see playing out here," Joseph Mason, an associate professor of finance at Drexel University in Philadelphia, said today in a Bloomberg Television interview.

Ambac reported a first-quarter net loss of $1.66 billion, or $11.69 a share. Its operating loss of $6.93 a share was larger than the $1.82 estimated by six analysts surveyed by Bloomberg News.

Ambac interim Chief Executive Officer Michael Callen tried to calm investors, saying "the worst may be behind us." He also said the company won't file for bankruptcy.