I thought the worst was over. After the first three months of 2008 threw more curveballs at bond insurer Ambac Financial (NYSE: ABK) than it could dodge, I didn't think the news could get much worse.

It did.

Ambac reported a first-quarter net loss of $1.66 billion, or $11.69 per share, in stark contrast to a profit of $213 million, or $2.02 per share, in the same period last year. The mounting troubles led to negative revenue of $1.56 billion, down from a positive $462 million in the first quarter last year. Yikes.

Reacting to the sour news, shares of Ambac plummeted more than 40% Wednesday to their lowest levels ever since the company went public in 1991. The stock has now fallen 96% in the past year.

A good chunk of the quarter's drop was attributable to a $1.73 billion mark-to-market loss on credit derivatives. The loss included a $940 million credit impairment on collateralized debt obligations (CDOs) primarily linked to residential mortgage-backed securities. Ambac also set aside a little more than $1 billion in loss provisions to cover expected claims on mortgage-related securities. Mayhem in the debt market has pounded Ambac and rival MBIA (NYSE: MBI), which both face a possible mountain of liability on the CDOs insured in case of default.

Net premiums written slid 38% from the same period last year. Anxiety surrounding bond insurers' futures has caused those looking for bond insurance to turn to more reputable players such as Berkshire Hathaway (NYSE: BRK-A), which recently set up a municipal bond insurer to capitalize on the market's instability.

What's next for Ambac? It's hard to imagine how a business where credibility is a key asset can survive such a tumultuous ordeal. Even if it manages to endure the uphill battle it's facing and convinces rating agencies such as Moody's (NYSE: MCO) that it's worthy of an ample credit rating, the colossal share dilution Ambac has undergone to stay afloat leaves existing shareholders scrambling for scraps of the battered company. The amount of damage from insuring CDOs over the past several years may very well be enough to take down what was once a healthy, cash-generating business model.

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