Moody's Cuts Ambac Ratings

Moody's just downgraded Ambac after the huge losses reported today. Ambac needs to post collateral for its GIC contracts and needs to transfer money from its insurance subsidiary. If the regulator doesn't allow the transfer, it'll likely have to file for bankruptcy right away.

Moody's cut Ambac Financial's senior unsecured debt rating by four notches to Ba1, which is considered non-investment grade, or "junk" status, from A3.

Earlier Wednesday, the New York-based insurer posted a third-quarter loss of $2.43 billion, as it increased loss reserves for mortgage-backed securities and took write-downs on credit derivatives.

Moody's also cut the insurance financial strength rating of Ambac Assurance Corp. and Ambac Assurance UK Ltd. to Baa1, which remains investment grade, from Aa3.

The ratings agency said the downgrade resulted from expectations for continued losses, the company's diminished business prospects and its "impaired financial flexibility."

The insurance subsidiary's financial strength rating remains investment grade because Moody's thinks the company has enough cash to provide a cushion above expected loss levels.

The regulator has a really tough decision to make. If he lets Ambac file for bankruptcy, the CDS buyers will require accelerated payments which will hurt non-CDS insurance buyers (the insurance regulators seem to care more about the non-CDS insurance than the CDS-type insurance.) If he does let the capital to be transferred out, his decision may be called into question if there is a capital shortfall at the insurance subsidiary in the future.