By Alistair Barr
Freddie Mac (FMCC), the government-owned mortgage giant, has
waded into litigation against Ambac Financial Group Inc. (ABK),
joining a group of hedge funds that are challenging the
reorganization of the troubled bond insurer.
Freddie Mac owns about $4.5 billion of mortgage-related
securities that are insured by Ambac Assurance Corp., the main
subsidiary of Ambac Financial.
Earlier this week, Freddie joined hedge funds including King
Street Capital in arguing against a deal Ambac struck earlier this
year with major banks including Citigroup Inc. (C) and Deutsche
Bank AG (DB).
The mortgage giant also joined a related legal challenge
launched earlier this year by investment-management firms including
Eaton Vance (EV), according to a letter sent by Freddie's attorney
Thomas Armstrong to the Wisconsin Court of Appeals on Sept. 20.
The litigation will decide the fate of policies backing more
than $60 billion of securities. It also has broader implications
because critics argue Ambac policyholders are being treated
differently, undermining a basic tenet of the insurance
industry.
The legal battles stem from Ambac's doomed foray into
guaranteeing mortgage-related securities at the height of the
housing boom.
Originally an insurer of sturdier municipal bonds, Ambac sold
guarantees on billions of dollars of mortgage-backed securities and
more complex vehicles known as collateralized debt obligations, or
CDOs. When the housing meltdown hit, many of these securities
turned toxic, leaving Ambac with heavy losses that threatened its
survival.
In March, the Wisconsin Insurance Commissioner, the main
regulator of Ambac Assurance, seized the most-troubled parts of its
business to protect hundreds of billions of dollars in muni bond
guarantees.
Policyholders with guarantees on $64 billion worth of soured
assets like residential mortgage-backed securities and CDOs were
put into a so-called Segregated Account.
The regulator has halted claim payments on the policies until
the seizure plan is approved in court. Once the Segregated Account
is able to pay claims, policyholders will get roughly 25 cents on
the dollar in cash. The rest will be paid in surplus notes, a type
of IOU.
Meanwhile, policyholders that remain in Ambac's main General
Account can still make claims and get paid in full. That's sparked
criticism that the plan treats some policyholders better than
others.
Freddie Mac's legal challenge focuses on the agreement earlier
this year between Ambac Assurance and big banks including Citi.
Ambac agreed to pay the banks $2.6 billion in cash and $2 billion
of new surplus notes. In return, the banks agreed to commute, or
tear up, $16.4 billion of guarantees on CDOs that they bought from
Ambac.
This settlement may "jeopardize the prospects for successful
rehabilitation of the Ambac Segregated Account [which is completely
dependent upon the General Account for funding]," Armstrong,
Freddie's attorney, wrote in the Sept. 20 letter.
The banks involved in the deal may be getting better treatment
than Ambac policyholders in the Segregated Account, the lawyer
added.
Freddie Mac owns $2 billion of residential mortgage-backed
securities that are insured by Ambac and have ended up in the
Segregated Account. It owns another $2.5 billion of commercial
mortgage-backed securities and mortgage-revenue bonds that are
insured by Ambac and "appear" to still be in the General Account,
Armstrong noted.
Wisconsin laws suggest that the banks should be paid after, not
ahead of, Segregated Account policyholders like Freddie Mac, the
lawyer wrote.
-Alistair Barr; 415-439-6400; AskNewswires@dowjones.com