Ambac downgrade requires $3.2 bln more collateral

NEW YORK Nov 6 (Reuters) - Ambac Financial Group ABK.N will need to post an additional $3.2 billion in collateral, after Moody's Investors Service on Wednesday cut its ratings on the bond insurer, according to research firm CreditSights.

The collateral needs could also leave the company with a $2.8 billion cash shortfall at its financial services unit, CreditSights analysts said in a report late on Wednesday.

Moody's cut Ambac Assurance Corp's rating four notches to "Baa1," the third-lowest investment grade, from "Aa3."

Ambac's third-quarter loss and the possibility of even greater expected losses in extreme stress scenarios were both reasons for the downgrades, Moody's said.

The diminished ability of Ambac to write new business and its impaired financial flexibility were also reasons, the rating agency added.

Ambac's shares fell 22.6 percent on Thursday to $1.55.

The cost to insure Ambac Financial's debt for five years with credit default swaps jumped to an upfront cost of 35 percent the sum insured on Thursday, from 26 percent on Wednesday, in addition to annual premiums of 5 percent, according to CMA DataVision.

That means it would cost $3.5 million in a lump sum to insure $10 million for five years, plus payments of $500,000 per year.

Ambac said in a statement that it "can find no justification for Moody's actions," and that the downgrade will increase pressure on its financial services business.

This business is comprised of Ambac's swap agreements and Guaranteed Investment Contracts.

"Ambac noted in its conference call that it is working closely with its regulators to receive permission to use the resources of Ambac Assurance to support this liquidity issue," CreditSights said.

"Meanwhile, $1.1 billion of the company's $9.9 billion fixed income investment portfolio is backed by short-term investments which may be sold to shore up cash," it added.

Ambac said that Moody's action fails to account for federal efforts to improve liquidity of financial institutions, as well as early termination of some of its contract exposures.

For example, Lehman Brothers' bankruptcy is expected to result in the early terminations of approximately $1.2 billion in GIC liabilities, Ambac said. Approximately $900 million is also expected to terminate before the end of September and the remaining $300 million by the end of October, the bond insurer said.

Moody's also cut its ratings on Ambac Financial Group's unsecured debt into junk territory, with a four-notch downgrade to "Ba1," one step below investment grade, from "A3."

Ambac is attempting to revive its business by reactivating its Connie Lee Insurance Co as a new municipal bond insurer.

"Ambac's current capital position is solid but its longer-term viability is in serious jeopardy," CreditSights said. (Reporting by Karen Brettell; Editing by James Dalgleish)