Ambac rating still on review for downgrade: Moody's

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Ambac is in talks with banks and others to raise about $3 billion of capital, according to people familiar with the matter.

NEW YORK (Reuters) -Moody's Investors Service on Friday said ratings on the insurance arm of Ambac Financial Group <ABK.N> remain on review for downgrade, adding the insurer is around $2 billion short of its "target" capital level for an "Aaa" company.

Ambac is in talks with banks and others to raise about $3 billion of capital, according to people familiar with the matter.

If successful, Ambac is expected to meet Moody's target level for the top rating, the rating agency said in a statement.

Ambac's ratings are on review as rating agencies view its capital as insufficient due to losses the insurer is expected to take from insuring risky residential mortgage backed debt.

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The loss of the top ratings would devalue insurance policies it has written on assets including municipal debt and structured deals known as Collateralized Debt Obligations, possibly sparking a sell off in the securities.

Ambac, the second largest U.S. bond insurer, insures $556 billion of bonds, the majority of which is debt sold by state and local governments.

Moody's said its stress tests show Ambac could face losses of around $12.1 billion from insuring risky residential mortgage-backed debt and that the insurer has around $13.7 billion to pay claims.

This level is above the minimum required for the top rating, but below the target level by about $2 billion, Moody's said.

The most likely scenario, however, is that Ambac will incur losses of around $4.2 billion over the life of its portfolio, Moody's added.

SNAG

CNBC television reported on Friday that the effort to arrange a rescue of the insurer has hit a significant snag over the amount of capital the banks involved would have to inject into the company.

The snag involves a dispute with the ratings agencies whose verdict is crucial to Ambac retaining its debt rating, CNBC said, adding that the agencies are calling for the banks to inject more capital given the structure they are proposing for the business.

Ambac is looking at separating its municipal bond insurance business, which is unlikely to face big payouts, from its structured finance insurance business, which is likely to make big payouts in coming years.

The separation of the two businesses would reduce the risk of the arm insuring municipal debt losing its "Aaa" rating, though the structured finance arm would be more challenged to hold the top ratings, Moody's said.

(Reporting by Karen Brettell; Editing by Richard Satran)