Ambac Looking at Break Up, Isolation of Mortgage-Related Guaranty Business

Ambac Financial Group Inc. is considering a split of its municipal and mortgage-related bond insurance businesses, the Wall Street Journal reported on Monday. The news makes Ambac the latest monoline — along with FGIC Corp. — to consider a break up of its business as the mortgage crisis has stripped the insurer of most of its previously-held AAA ratings.

The monolines provided the top-rated portions of MBS deals with a guarantee that essentially is designed to serve as a private-party proxy for the government guarantee that exists on Fannie/Freddie/Ginnie bond issues. But the strength of that guarantee is only as good as the rating of the firm that provides it, which means that downgrades to bond insurers are wreaking havoc on the already unsteady mortgage-backed bond market, as investment-grade securities are seeing their top ratings vanish.

From the WSJ’s coverage of Ambac:

A halving of Ambac would create one unit that insures municipal debt and one that would cover rapidly diminishing securities tied to the mortgages in a structure that effectively creates a so-called “good bank” and “bad bank.”

… But the plan to split Ambac is complex and has required tens of hours in recent days. While a “good bank-bad bank” model has existed for decades, there isn’t a playbook for halving a bond insurer. A number of issues remain to be resolved, said a person familiar with the situation.

New York Insurance Superintendent Eric Dinallo had suggested a break-up of some monolines last week.

“We cannot allow the millions of individual Americans who invested in what was a low-risk investment [municipal bonds] lose money because of subprime excesses,� he said. “Nor should subprime problems cause taxpayers to unnecessarily pay more to borrow for essential capital projects.�