Jan. 18 (Bloomberg) -- MBIA Inc. and Ambac Financial Group Inc., the two biggest bond insurers, have a more than 70 percent chance of going bankrupt, credit-default swaps show.

Prices for contracts that pay investors if Armonk, New York- based MBIA can't meet its debt obligations imply a 71 percent chance the company will default in the next five years, according to a JPMorgan Chase & Co. valuation model. Contracts on New York- based Ambac imply 72 percent odds.

Ambac shares have plunged 71 percent the past three days as the company scrapped plans to raise equity capital and Moody's Investors Service and Standard & Poor's put the insurer on review for a downgrade. Fitch Ratings cut Ambac's AAA guaranty rating today. MBIA has dropped 47 percent since Jan. 15. Credit-default swaps on the companies, which rise as confidence erodes, are trading at record highs.

``In this market, a downgrade could mean the beginning of that company's eventual collapse,'' said Matt Fabian, an analyst with Municipal Market Advisors in Westport, Connecticut. While Fabian said he still expects the companies to keep their rankings, he said he has grown ``much more anxious.''

MBIA and Ambac are the largest of seven bond insurers that place their AAA stamp on $2.4 trillion of debt, including municipal bonds and securities linked to mortgages. Losing those rankings may cost borrowers and investors as much as $200 billion, according to data compiled by Bloomberg.

Dividend Cuts

Both companies slashed their dividends this month and announced plans to raise as much as $2 billion each. MBIA has lost 88 percent of its market value since the start of 2007 while Ambac's has fallen 93 percent after the insurers expanded into subprime-mortgage securities and collateralized debt obligations that are now slumping in value.

Ambac today said it's opting not to raise equity capital because of ``market conditions and other factors'' and ``is continuing to evaluate alternatives,'' according to a statement.

Ratings companies, which affirmed their assessments a month ago, are scrutinizing bond insurers to ensure they have enough capital to protect against losses. Standard & Poor's yesterday said industry losses on subprime securities will be 20 percent more than it initially forecast. S&P said that isn't enough to start downgrading the companies.

MBIA spokeswoman Elizabeth James and Ambac spokesman Peter Poillon didn't immediately return telephone calls for comment.

Investor Protection

MBIA and Ambac credit-default swap prices are soaring as investors rush to protect against the risk the companies won't make good on guarantees the bond insurers sold them on securities linked to mortgage bonds, corporate loans and other assets.

``Investors are concerned about counterparty exposure,'' Gregory Peters, head credit strategist at Morgan Stanley in New York, said in an interview on Bloomberg Television today. ``That's the overhang that the market has to contend with.''

Lehman Brothers Holdings Inc., the biggest U.S. underwriter of mortgage bonds, told investors last month that it was buying credit-default swaps to hedge against the risk that bond insurer guarantees on securities become worthless.

Merrill Lynch & Co., the biggest underwriter of collateralized debt obligations, said it will write off $2.6 billion in default protection from bond insurers, mostly from ACA Capital Holdings Inc., whose ratings were cut 12 levels to CCC in December.

`Material Jeopardy'

Credit-default swaps tied to MBIA bonds have risen 10 percentage points the past two days to 26 percent upfront and 5 percent a year, according to CMA Datavision in New York. That means it would cost $2.6 million initially and $500,000 a year to protect $10 million in MBIA bonds from default for five years.

Credit-default swaps on Ambac, the second-biggest insurer, have risen 11.5 percentage points to 26.5 percent upfront and 5 percent a year, prices from CMA Datavision show.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

Fitch today lowered its rating on Ambac's insurance unit two levels to AA and said it may cut further. Without its AAA rating, Ambac may be unable to write the top-ranked bond insurance that makes up 74 percent of its revenue.

`Two Options'

``They have two options,'' said John Giordano, a credit analyst at New York-based BlueMountain Capital Management, which manages $4.8 billion. ``One is you get the white knight who comes in and buys you and is a natural AAA and solves a lot of problems. And the other is maybe private equity. I don't think they can even touch the public markets, whether that be debt or equity. I can't imagine anybody's going to touch them.''

Ambac shares fell 4 cents to $6.20 today in New York Stock Exchange trading. MBIA fell 67 cents to $8.55.

``The ability of Ambac to survive as a going concern is now in material jeopardy,'' Rob Haines, an analyst at bond research firm CreditSights Inc. in New York, wrote in a report yesterday.

The default probability derived from the pricing model, which traders use to value the contracts, assumes a 40 percent recovery rate on the companies' bonds in the event of a default.

MBIA and Ambac are trading near levels reached by Countrywide Financial Corp., the mortgage lender battered by speculation it would file for bankruptcy before agreeing last week to be bought by Bank of America Corp.

Bonds Plunge

Ambac's $400 million of 6.15 percent bonds due in 2037 have plunged by 25 cents on the dollar this week to 35.4 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The yield has soared to 17.6 percent from 10.5 percent and the extra yield investors demand over government securities with similar maturities has widened 7.2 percentage points to 13.4 percentage points.

Ambac would survive without its AAA rating if it stopped trying to insure debt and let the existing policies wind down, shareholder Evercore Asset Management LLC wrote in a letter to directors that it released yesterday. Evercore had opposed Ambac's plan to raise capital.

Ambac's chief executive officer departed Jan. 16 after the company reported greater-than-expected writedowns on the bonds it insures. Moody's said the losses were ``significantly'' more than Ambac indicated.

Ambac said yesterday that the Moody's review was ``surprising.''

Assumptions

S&P assumes losses on mortgages made in 2006 to people with poor credit will reach 19 percent, up from its prior forecast of 14 percent, as housing prices decline more than it anticipated.

Under the new assumptions, losses for bond insurers may be $13.6 billion, 20 percent higher on average than those projected a month ago, S&P said yesterday. Ambac's projected losses are now $2.25 billion, 22 percent more than in December. MBIA's are $3.5 billion, an increase of 11 percent, S&P said.

The revised S&P assumptions probably won't require MBIA to raise more capital than it already plans, according to a statement on MBIA's Web site.

Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.

To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Christine Richard in New York at crichard5@bloomberg.net

Last Updated: January 18, 2008 17:37 EST