Does Ambac's Profit Indicate Bond Insurers Will Survive?

Bond Insurer Ambac announced a surprising fourth quarter profit of $558 million today. That's after a $2.34 billion loss in the fourth quarter of 2008. This news market quite a turnaround for the troubled insurer which has been ailing ever since the housing market's collapse. Like most of its competitors, losses from mortgage-related guarantees have plagued the firm. Does this improvement mark a change for the troubled bond insurance industry?

First, the company reports that the improvement was partially driven by a $472 million tax benefit that allows Ambac to carry back losses. Taking that away, the firm had a much smaller profit -- just $86.1 million. That is still much better than a loss in the billions, however.

Why else did Ambac improve? It incurred fewer residential mortgage-backed security (RMBS) losses. They were $385 million in 2009, down by 58% from its $916 million loss in the final quarter of 2008. The value of its credit derivatives portfolio also increased by $133 million. That compares to a $594 million loss the portfolio incurred in the same quarter a year prior.

Ambac's net investment income also improved -- up 8%. Net premiums declined by 19% year-over-year, however.

These results are certainly encouraging and explain why its stock is up around 70% this morning. The value of its credit derivatives will continue to improve as the market does. The severity of its RMBS if should also benefit if home prices have hit the bottom.

But it's too soon to know if Ambac and its brethren are out of the woods. Foreclosures continue to soar, which will lead to continued losses on RMBS. The housing market's fate after the home buyer credit expiration in April is also unclear. If employment and consumer sentiment levels don't improve, it's hard to imagine there will be much demand on the part of potential new home buyers to soak up the increasing inventory of houses. That won't bode well for home prices.

Still, today's news provides some reason for optimism. If the real estate market really has hit the bottom, any bond insurers who have lasted this long could manage to survive. Of course, that's a big "if."