By Walden Siew

NEW YORK (Reuters) - Moody's Investors Service on Tuesday dropped its immediate threat to cut the top "Aaa" rating of MBIA Inc's <MBI.N> insurance unit, staving off the prospect of more bank losses and market declines.

While downgrades are still possible, especially if MBIA, the world's biggest bond insurer, splits its business lines, the latest action eased market concerns over rating downgrades of bond insurers and the debt they guarantee.

"The affirmation of triple A is a big shot in the arm for the entire industry," said Donald Light, an insurance analyst at Celent, a consulting firm in Boston. "It shows that somebody in the bond insurance industry can take a step back from the brink."

MBIA's shares rose 4.8 percent to $15.28. Shares of Ambac Financial Group Inc <ABK.N>, the No. 2 bond insurer, were down 1.8 percent at $12.19, a day after jumping 15.9 percent in the wake of reports it was near a deal to shore up its financial position.

The news also boosted the outlook for financial firms. Moody's Corp <MCO.N> shares surged 8.7 percent to $42.31.

If Moody's or S&P had stripped MBIA of its top ratings, bond markets could have been sent into turmoil and new bond issuance could have slowed, cutting into Moody's revenue.

The cost of protecting bond insurers' debt with credit default swaps narrowed on Tuesday on optimism some bond insurers can maintain their top ratings.

Top bond insurer ratings are important because many banks and investors can hold only securities that have top ratings. Any bond insurer rating cut would result in downgrades of bonds they insure, resulting in billions of dollars of forced sales.

Moody's was the second major rating agency in as many days to say it would not cut MBIA Insurance Corp's crucial top rating, calming financial markets worried about more bank write-downs and investor losses.

"These rating actions reflect Moody's assessment of MBIA's ongoing efforts to strengthen its capital position," damaged by exposure to deteriorating subprime mortgages, Moody's said in a statement.

MBIA is done with significant dilutive capital raising, the company's chief executive said on Tuesday.

Speaking on CNBC television, MBIA CEO Jay Brown said: "Never say never, but I think we're through raising significant dilutive capital." He added that the company has "additional things to do" to show that the company is solid.

Moody's analyst Jack Dorer did not return phone calls seeking comment. MBIA's outlook is negative, indicating a Moody's downgrade is still possible over the next 18 months.

Standard & Poor's ended its review of MBIA's rating on Monday, saying it had grown more confident that MBIA could raise capital after the insurer sold $2.6 billion of debt and equity.

Financial institutions could face an additional $70 billion of write-downs if insurers' ratings are cut, according to Oppenheimer & Co.

Plans to split MBIA's municipal bond and structured finance business would increase the risk of a downgrade for the non-municipal business, Moody's said. The action on Tuesday did not reflect a possible split of MBIA's business, Moody's said.

"The proposals to split into the good insurance, bad insurance, are still very much on the table," Celent's Light said.

Five-year protection costs on Ambac Assurance Corp were quoted around 350 basis points, or $350,000 a year for five years to protect $10 million of debt, versus 377 basis points Monday, according to data from CMA DataVision. MBIA Insurance Corp's spreads narrowed to about 340 basis points from 360 basis points.

(Additional reporting by Dena Aubin and Dan Wilchins; Editing by Dan Grebler)