US: Credit Market

Ambac Still Needs Ratings Firms To Approve Rescue

Charles Gasparino, CNBC On-Air Editor

A consortium of banks has largely finalized a deal to recapitalize troubled bond insurer Ambac Financial Group and is now trying to sell the plan to the rating agencies to save Ambac's triple-A rating, CNBC has learned.

Though Standard & Poor's reaffirmed Ambac's rating on Monday, the insurer is still under review and could be downgraded in the coming days until details of the proposed recapitalization are presented and approved.

A tentative structure for up to $3 billion in capital for Ambac has been agreed to by the consortium, which includes Citigroup and Wachovia. The banks are trying to save Ambac, as well as other bond insurers, because a ratings downgrade could force the banks to write down billions more of their own debt that is backed by Ambac's insurance and current Triple A rating.

It's unclear exactly when the deal will be announced officially, but it will hinge on getting the rating agencies to sign off on it, so it could be later this week or early next week.

Though the structure of the deal is largely finalized, rating agency approval is crucial because  bankers want to make sure that Ambac isn't downgraded after they put money into the  bond insurer.

Bankers and New York insurance regulators are still confident the deal will get done, but caution that it could blow up at any time depending on the what the rating agencies decide.

The big rating agencies--Moody's, Standard & Poor's  and Fitch --have been widely criticized for not catching the growing debt problems at the bond insurers earlier, so it's not out of the question that they will demand more capital be injected into Ambac.

On Monday, S&P reaffirmed reaffirmed the Triple A rating on MBIA , the nation's biggest bond insurer, as well as Ambac, sparking a rally by both stocks and the market in general.

S&P ended its downgrade review for MBIA's Triple A rating, citing success by the largest U.S. bond insurer in raising new capital, though the negative outlook suggests that the rating agency is still concerned about MBIA's ability to maintain its Triple A rating.

MBIA, Ambac Update

But Ambac's triple A rating remained on review for downgrade until details of the planned recapitalization are clearer. Ambac remains on "negative creditwatch," which is worse than "negative outlook" because the time horizon for a possible downgrade is shorter.

Still, the reaffirmation of the triple A rating is considered a positive for Ambac's stock pending the capital infusion.

Moody's is also expected to announce something this week on the bond insurers.

Bond insurers got into trouble by moving beyond guaranteeing safe municipal bonds and insuring risky subprime-related debt. The resulting loses are now threatening their prized triple A rating, which they need to attract new clients. Current clients, such as the banks, would also lose the triple A rating if the insurers get downgraded, forcing further writedowns of their debt.

If an Ambac deal is reached, it 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 shore-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 some analysts are increasingly skeptical that even with the infusion of cash, downgrades can't be avoided in the future 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. Recently, MBIA announced that it 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.

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.

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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.