Banks Closing in on Deal for Ambac Bailout

Bankers working on the deal to bail out troubled bond insurer Ambac say progress is being made on a recapitalization plan that could save the bond insurer's triple-A rating.

The consortium of banks, which includes Citigroup

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[C  Loading...      ()   ] and Wachovia could announce the deal as early as Monday or Tuesday. Although the structure of the deal is still uncertain, sources indicated the deal could include both equity infusions and lines of credit.

To be sure, the entire deal could fall apart; bankers have gotten close in the past. Nevertheless sources close to the negotiations between the banks and the New York State insurance department say significant progress is being made on a potential deal.

If reached the deal would be a big victory for New York State Insurance Commissioner Eric Dinallo, who has been goading Wall Street to work out a deal for about six weeks.

Dinallo has been working on separate plans with the bank consortium that may infuse capital and provide lines of credit to sure-up the bond rating businesses at FGIC and Ambac and prevent downgrades. MBIA recently raised several billion dollars in new capital from Warburg Pincus.

But analysts are increasingly skeptical that even with the infusion of cash downgrades can be avoided because of the massive losses the insurers might take on their coverage of CDOs and other bonds that are packed with depressed subprime loans. As evidence, they point to recent management changes at MBIA and other moves; just yesterday, MBIA announced that wants to split its municipal bond business to shield it from the losses on its business of insuring CDOs. The move is being seen as a way to placate regulators and bond raters as a decision nears.

Meanwhile, as troubled bond insurers like MBIA and Ambac fight to maintain their triple-A ratings, officials at these firms are pondering how their businesses might look if they do indeed get downgraded, CNBC has learned.

The decision by the big ratings agencies, Moody's, Standard & Poor's and Fitch is imminent, and at least one of the raters could make an announcement sometime today.

Bond insurers guarantee bonds held by investors from default, agreeing to pay interest and principle if the issuer doesn't do so. But maybe more important to investors is that insurers also lend their triple-A rating, the highest rating in the bond market, to the bonds as part of their insurance package.

People inside the New York State insurance department, which has taken the lead in trying to prop up the insurers, say both MBIA and Ambac have enough assets to cover losses stemming from their insurance of depressed collaterialized debt obligations, or CDOs, held by large banks like Citigroup.

The bigger question is whether these firms can compete with ratings less than triple-A, particularly now that the bond insurance business will be focusing on covering bonds of municipal governments. Many large investors of municipal debt can only hold securities with triple-A ratings.

In addition, a lower rated MBIA

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[MBI  Loading...      ()   ] and Ambac

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[ABK  Loading...      ()   ]would also have to compete against other triple-A rated insurers, like the one Warren Buffett says he's creating.

Related Story: Buffett's Berkshire Backs over 100 Munis in 2 Days

Meanwhile, a downgrade of MBIA and Ambac could pose big problems for the banks that hold bonds they insure. Analyst Meredith Whitney said on CNBC yesterday that the downgrades could cause writedowns of another $75 billion at the big banks.

Of course, MBIA and Ambac could still convince the rating agencies to maintain their triple-A's, something that New York State insurance commissioner Eric Dinallo has been working on for the past month.

As reported on CNBC, Dinallo is working on separate plans with consortiums of bank that may infuse capital and provide lines of credit to sure-up the bond rating businesses at FGIC and Ambac and prevent downgrades. MBIA recently raised several billion dollars in new capital from Warburg Pincus.

But analysts are increasingly skeptical that even with the infusion of cash downgrades can be avoided because of the massive losses the insurers might take on their coverage of CDOs and other bonds that are packed with depressed subprime loans. As evidence, they point to recent management changes at MBIA and other moves; just yesterday, MBIA announced that wants to split its municipal bond business to shield it from the losses on its business of insuring CDOs. The move is being seen as a way to placate regulators and bond raters as a decision nears.