Standard & Poor’s Tuesday evening slashed Ambac Assurance Corp.’s financial-strength rating to junk, saying assumed losses on insured mortgage bonds could wipe out the company’s equity.

Ambac’s rating was cut to CC with a developing outlook from BBB, where it had been on negative credit watch.

Standard & Poor’s also cut the counterparty rating on Ambac Financial Group Inc. to CC, with a negative outlook, from BB.

Ambac at the end of March reported policyholders’ surplus — or assets in excess of liabilities — of $373 million.

Though $1.18 billion weaker than it was just three months earlier, this was still in compliance with regulatory requirements for policyholders’ surplus.

Standard & Poor’s wrote Tuesday that it is concerned that “significant deterioration” in Ambac’s book of insured residential mortgage-backed bonds could push the policyholders’ surplus below zero.

When insurers estimate losses on policies, they have to reserve money to pay claims. Those reserves sap money from assets, thus siphoning money from the policyholders’ surplus.

Ambac on Monday said it expects $1.6 billion in impairments to collateralized debt obligations composed of asset-backed securities and increased loss reserves of $800 million.

The result, Standard & Poor’s said, could be negative policyholders’ surplus as of the quarter that ended June 30.

Ambac insures $413.3 billion of debt, including $231.9 billion in municipal bonds.

Standard & Poor’s is concerned about losses in the $7 billion of subprime bonds insured by Ambac.

About a month ago, Standard & Poor’s downgraded Ambac to BBB from A, saying the company was effectively in run-off — meaning not writing new business and staying alive only to collect premiums and pay claims on existing policies.

That downgrade came shortly after Ambac delayed indefinitely the launch of Everspan Financial Guaranty Corp., which it had planned to be a muni-only bond insurer. The company had trouble raising enough capital to split the municipal insurance book into the new subsidary.

Like most of the other bond insurers, loss assumptions on structured finance deals have wreaked havoc on Ambac’s entire business, including the relatively stable public finance insurance business.

Ambac’s stock, which slipped 12 cents Tuesday, sank an additional 3 cents in after-hours trading to 80 cents. The stock had peaked at $96.10 in May 2007.


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