Ambac Financial Group (ABK)

Ambak has fallen to an attractive price after a non-recurring loss on insured collateralized debt obligations. But with wider spreads and less liquidity, Ambac stands to achieve greater margins and business going forward.

Ambac(ABK) announced second quarter 2008 net income of $823.1 million, or net income of $2.80 on a fully-diluted per share basis. This compares to second quarter 2007 net income of $173.0 million, or net income of $1.67 on a fully-diluted per share basis. The increase in the second quarter of 2008 is primarily due to recording net mark-to-market gains on credit derivatives, increased accelerated premiums from refundings, and loss reserve reductions on the direct residential mortgage-backed securities (RMBS) portfolio, partially offset by market losses on RMBS within the financial services investment portfolio.

Short translation? The write-downs that killed earnings are becoming write-ups and helping them.

As home prices rise people are less likely to walk away from the huge loss on their home and thus reduce defaults: this was a key problem stated by Ben Bernanke last year. As unemployment is peaking less people will default on their home. As home sales slowly begin to increase, as they already have, mbs product revenue will increase as well. Increasing revenue; An increase in the value of assets; The dramatic reversal in rate of defaults; All this coupled with the fact that ABK has over 15% of all shares outstanding sold short really creates a breeding ground for an explosive but probably short lived rally.

Fewer foreclosures