Ambac tightens on report of rescue

NEW YORK (Reuters) - U.S. corporate bonds were mostly unchanged on Friday, though Ambac's spreads tightened following news that a group of large banks have joined to find ways to shore up the ailing bond insurer.

Bond insurers, which are at risk of losing their key "AAA" ratings after insuring repackaged subprime mortgages, are looking to raise capital to protect their ratings.

The group looking at Ambac (ABK.N) has no definite time horizon for crafting a plan, a person brief on the talks said on Friday.

In the credit derivative market, the main index of credit default swaps tightened by about 2 basis points to about 106.4 basis points.

New York Insurance Superintendent Eric Dinallo has been working for weeks to craft a rescue plan for bond insurers, though analysts have questioned how he will gain the support of banks, who are not under his authority.

"Obviously, it's positive that they're talking, but to get a deal done is entirely different," said Mirko Mikelic, portfolio manager for Fifth Third Asset Management in Grand Rapids, Michigan. "There's no one regulatory entity that can compel these parties to cooperate."

Any bailout plan will thus be trickier than the Federal Reserve-led rescue organized for hedge fund Long Term Capital Management in 1998, Mikelic said.

"It will benefit everyone if everyone participates, but you don't want to be the one taking the risk on yourself," Mikelic said. "Individually, it doesn't look that great to participate in such a deal."

CNBC also reported on Friday that the head of the Federal Reserve Bank of New York, Timothy Geithner, is keeping close track of Dinallo's efforts but is not trying to take them over.

Ambac's debt protection costs plunged to 6 percent of the amount insured in an upfront payment, plus 500 basis points annually, down from an upfront cost of 17 percent plus 500 basis points annually on Thursday, according to data from CMA DataVision.

The cost of protecting MBIA's (MBI.N) debt with credit default swaps fell to 13 percent upfront plus 500 basis points annually, down from 16 percent upfront plus 500 basis points on Thursday, according to data from CMA DataVision.

Credit protection trades on an upfront basis when investors consider a company distressed.

Concerns about bond insurers losing their top "AAA" ratings had sent their credit spreads surging in recent weeks.

In one sign of the negative sentiment, a $1 billion issue of surplus notes sold by MBIA on January 11 at 100 cents on the dollar traded down to the low-70s the following week. The notes rose on Friday to 91.5 cents on the dollar, up from 88.5 cents on Thursday, according to an investor.

(Reporting by Dena Aubin, Dan Wilchins and Karen Brettell; Editing by James Dalgleish)