'Monoline' insurers at risk of losing AAA credit rating

The insurance that is propping up what remains of the battered mortgage-backed debt markets may be worthless, investors fear.

Shares in the biggest so-called "monoline" insurers, who guarantee exotic debt products against the risk of default, plunged yesterday as credit rating agencies put investors on notice that they may downgrade the companies' debt. There is growing concern that the companies, MBIA and Ambac, do not have the funds to cover their promises, now that Americans are defaulting on mortgages in record numbers.

Ambac's market value almost halved yesterday morning after Moody's said it was reconsidering the company's AAA credit rating. The news threw into confusion the fundraising plan that Ambac had outlined a day earlier, which included a $1bn (£500m)-plus bond issue.

Wall Street banks take out insurance when they want to limit the risk of losses on mortgage-backed securities (MBSs) and collateralised debt obligations (CDOs), which are packages of MBSs. Insurers such as MBIA, Ambac and ACA guarantee to pay the interest and the principal on bonds, if there is a default.

However, if the insurer becomes unstable, the insurance could be worthless and the banks may have to take larger losses on the underlying derivatives. Because a small insurer, ACA, had its debt downgraded to junk status last month, Merrill Lynch took a $2.6bn loss on its insurance yesterday.

Moody's said it had become concerned over Ambac's creditworthiness after it admitted it would lose about $1.1bn CDOs. The agency said it would review its ratings on the whole monoline insurance industry.