The heat on Ambac gets better, this just in from Bloomberg.com

Feb. 5 (Bloomberg) -- Downgrades of bond insurers, including MBIA Inc. and Ambac Financial Group Inc., may lead to cuts in credit ratings at banks, Standard & Poor's said.

If more bond insurers lose their top credit ratings, the markets in which they back debt, including municipal bonds and structured finance, could slow, affecting bank profits, S&P said in a report today. Bond insurer downgrades also could affect banks directly by causing them to recognize more losses and reverse gains in securities they hold guaranteed by the bond insurers, S&P said.

``We believe that the specific, identifiable effect on banks may be significant and, in a few cases, could lead to downgrades,'' Tanya Azarchs, a New York-based S&P analyst wrote in the report.

The collapse of the U.S. subprime mortgage market has led to about $146 billion of losses and markdowns at securities firms and banks since the beginning of 2007. They may report more losses if the bond insurers falter because the insurers have backed $125 billion of collateralized debt obligations tied to loans to borrowers with poor credit, S&P said.

Those contracts are concentrated at a small number of banks, S&P said. ``Few banks have disclosed how much that exposure is,'' the report said.

CDOs repackage assets such as mortgage bonds and buyout loans into new securities with varying risk.

 Guarantee Contracts

Banks that have disclosed how much of their CDO holdings are offset by guarantee contracts include Citigroup Inc., which said it has $10 billion of insurance on top-rated CDOs, and Merrill Lynch & Co., which has nearly $20 billion of such contracts, and Canadian Imperial Bank of Commerce, with $9.9 billion, S&P said. Citigroup and Merrill are both based in New York and Canadian Imperial is based in Toronto.

In addition to shielding them from losses, these contracts with bond insurers allowed the banks to book profits in their CDOs, S&P said. Downgrades of bond insurers could result in a need to reverse those gains, the New York-based unit of McGraw- Hill Cos. said.

S&P, Moody's Investors Service and Fitch Ratings are taking another look at the bond insurers to see if they have enough capital to protect their top ratings.

S&P has downgraded FGIC Corp.'s insurer, Financial Guaranty Insurance Co., to AA from AAA. It's also downgraded ACA Financial Guaranty Corp. to CCC from A. It's reviewing the AAA insurance ratings at MBIA, Ambac, the two largest bond insurers, and Security Capital Assurance Ltd.