Moody's Investors Service reiterated Monday that the possible bankruptcy of Ambac Financial Group is unlikely to affect policyholders of its bond insurer subsidiary. In addition, policyholders will benefit from recent growth in the insurer’s statutory surplus, the rating agency said.

Ambac Assurance Corp., the Wisconsin-based, junk-rated municipal bond insurer, maintains the third-largest insured public finance portfolio in the industry with $213 billion outstanding as of June 30.

Its parent has been warning since November that it may face bankruptcy as early as 2011. In its second-quarter earnings filing last week, Ambac Financial said it has "insufficient capital to finance its debt service and operating expense requirements beyond the second quarter of 2011."

Ambac Financial is in "a very weak liquidity position," Helen Remeza, senior analyst at Moody's, wrote in a weekly credit outlook. She noted that, as of June 30, the company held $56.7 million in cash, owed $122 million in debt payments due in August 2011, and carried $1.2 billion in outstanding senior debt.

Moody's rates the holding company C, indicating "a high likelihood of default" with diminished recovery.

Remeza said she believes that Ambac Assurance, a distinct legal entity, could continue operating without interruption.

Ambac Financial "is currently pursuing raising additional capital and restructuring its outstanding debt through a prepackaged bankruptcy proceeding," Remeza said. "This would save it time and money in court, compared to an ordinary Chapter 11, because the major stakeholders would agree on a restructuring plan beforehand."

Firms can emerge from successful prepackaged bankruptcies in fewer than six months, Remeza said.

Ambac Financial wouldn't be the first bond insurance holding company to test this assumption.

Former rival FGIC Corp., the holding company of beleaguered bond insurer Financial Guaranty Insurance Co., earlier this month filed for Chapter 11 protection. It would be premature to say conclusively that FGIC Co. is unaffected by the bankruptcy, but a spokesman for the New York Insurance Department said last week its operations should not be impacted.

Remeza also said the June agreement between Ambac Assurance and policyholders of credit default swaps "significantly improved" the insurer's capital position and mitigated the risk of a regulatory capital breach.

The settlement, which is being contested in Wisconsin courts by municipal bondholders who argued it would harm the ability of the insurer to fulfill future claims, helped to boost Ambac Assurance's statutory surplus to $1.5 billion in the second quarter, up from $160 million three months before.

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