Is This the Last Straw for Ambac?

Bond insurer Ambac (NYSE: ABK  ) has seen its fair share of wretched stock swings in the past few months, but Wednesday's 20% plunge might be the most telling.

After investors patiently waited for news about a rumor of a bank consortium bailout by the likes of Citigroup (NYSE: C  ) , Wachovia (NYSE: WB  ) , and UBS (NYSE: UBS  ) , New York-based Ambac announced Wednesday it would seek to raise capital by selling $1 billion in stock and $500 million in equity units to save its AAA credit rating.

Welcome news? It sure didn't soothe investors' nerves. And maybe for good reason.

With this decision, three sour points remained to plague Ambac and its biggest rival, MBIA (NYSE: MBI  ) :

  • The ugly structured finance division will remain married to the still-lucrative municipal division.
  • Nobody is quite sure if $1.5 billion is enough to do the trick.
  • There's no bank backstop for the capital raising, so there's no assurance the $1.5 billion can be raised.

McGraw-Hill's (NYSE: MHP  ) Standard & Poor's ratings agency was quick to add that if the $1.5 billion was successful, S&P would likely remove the credit-watch status it had placed on Ambac -- but Ambac would likely maintain a "negative outlook."

Those aren't the words investors who've been sweating bullets want to hear. Anything short of "AAA status is guaranteed" was bound to come as a disappointment.

Word of a "negative outlook" spread far beyond Ambac's battered stock. Credit default swaps -- derivatives used to make bets on whether a company will be able to repay its bonds -- insuring $10 million of Ambac's debt now stand at $530,000.

You can think of that this way: The price of insuring Ambac's debt now stands at 5.3%. That's a hefty premium -- way above what a true AAA status would fetch -- and implies investors are anything but optimistic in Ambac's ability to pull through as a healthy company.

Help? Not from us 
Because it had been hinted in the past, the decision to keep the CDO and municipal divisions under one roof didn't come as a surprise. Some estimate banks could lose as much as $70 billion if bond insurers go kaput, on top of the record losses they've already endured. With such dire consequences, banks would undoubtedly fight to the death before that happened.

That said, the fact that those banks don't have more of an active hand in the latest capital-raising efforts is quite intriguing. Just last week, it was reported a bank consortium had pulled together $2.5 billion to inject into Ambac. That sent shares soaring on hopes its future would be saved, even if it meant breaking apart.

But those talks broke down after Ambac balked at breaking up, and ratings agencies hinted the $2.5 billion wouldn't guarantee a pristine credit rating.

Fast-forward one week, and now we have Ambac attempting to raise $1.5 billion, without help from banks. And with a current market cap around $800 million, raising $1 billion in stock sales would mean more than doubling total shares outstanding. That's not a fun way to fund a recovery.

Batten down the hatches
That leaves bond insurers in the same pool they've been swimming in for the past several months: inundated by uncertainty. Berkshire Hathaway's (NYSE: BRK-B  ) offer to inherit the municipal insurance portfolio has expired. Opportunistic investor Wilbur Ross chose to invest in rival insurer Assured Guaranty. And as of today, the bank consortium bailout looks like it fizzled.

What's next? We may have (finally) come to a time when daily breaking news stories begin to slow, rampant rumors fade, and only one activity is left to uncover bond insurers' future: waiting.

That may not be a bad thing. With so much turbulence and emotion embedded in the market, giving investors a time out and room to focus on more material events -- like actual credit downgrades -- might help to remove Mr. Market's vicious swings and promote clarity.

Is this the last straw? With a stock chart that resembles an EKG monitor, let's hope so.

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