Moody's Investors Service lowered the rating of the senior unsecured debt of Ambac Financial Group to 'C' from 'Ca.'

The rating agency also placed the 'Caa2' insurance financial strength ratings (IFSR) of Ambac Assurance Corp. (ACC) on review for possible upgrade and the 'Caa2' IFSR for Ambac Assurance UK (AUK) on review with direction uncertain.

The rating actions may have implications for certain transactions wrapped by AAC and AUK.
Yesterday, the Wisconsin Office of the Commissioner of Insurance ordered AAC to handover its subprime mortgage-related contracts to “protect policyholders, including investors in thousands of state and local municipal bond issues,” according to a separate statement.

It will suspend payments totaling about $120 million for March to holders of these contracts. These policy holders include banks, pension funds, hedge funds and other insurance companies. As long as the regulator is overseeing these contracts, the monthly payments beyond March are also suspended.

AAC will set up a segregated account for certain policies insuring or relating to credit default swaps; all of its RMBS obligations; (iii) certain other identified policies insuring troubled credits; (iv) certain student loan policies; and certain reinsurance agreements.

The segregated account is supported by a $2 billion secured note issued by Ambac and an aggregate excess of loss reinsurance agreement provided by Ambac.

Moody's said that policies allocated to the segregated account are no longer appropriately considered to be senior policyholder obligations of AAC and that, consequently, Moody's insurance financial strength rating for AAC would not apply to such exposures.

The liabilities of AAC under the AUK reinsurance agreement have also been allocated to the segregated account, and they are subject to the same payment terms as the other obligations under the segregated account.

The rating of AUK may be lowered if it is not successful in its efforts to terminate the reinsurance agreement and obtain cash in lieu of previously ceded reserves.

The downgrade of Ambac Financial's senior debt rating to 'C' also reflects the heightened risk of default and very low ultimate recovery on the debt, whether through distressed exchange or potential bankruptcy proceedings, due to the holding company's modest cash position and limited financial flexibility.

In Moody's view, it is unlikely that the holding company will be able to access operating company resources over a reasonable timeframe to satisfy its obligations.

Moody's insurance financial strength ratings are based on the ability of insurance companies to repay punctually senior policyholder claims and obligations and the rating agency believes that policies allocated to the segregated account are no longer senior obligations of Ambac Assurance Corp.

As a result, wrapped transactions allocated to the segregated account will be rated at the published underlying rating (and for structured securities, the published or unpublished underlying rating).

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