Markets buoyed by hopes of $3bn Ambac bail-out

The crisis facing the two big US bond insurance companies, vital cogs in the credit markets, appeared closer to a solution yesterday, bringing relief to the battered credit default swap market.

Standard & Poor's, the credit rating agency, signaled that it was no longer expecting to cut its view of the creditworthiness of MBIA, the biggest so-called "monoline" insurer, which guarantees hundreds of billions of dollars of credit market instruments against the risk of default.

A cut to the gold-plated triple-A credit rating of either MBIA or its rival Ambac could have caused a cascade of new losses for Wall Street banks, which are relying on the monolines to cover further losses on many credit market investments. News that S&P had taken MBIA off its "credit watch negative" list helped boost the credit markets and the stock market alike. The Dow Jones Industrial Average rallied to close up 189 points at 12,570.22.

Growing hopes of a $3bn (£1.5bn) capital injection to bail out Ambac had also brought relief to the credit default swap market yesterday. A group of banks including Citigroup, Royal Bank of Scotland and Barclays are working with Ambac to come up with a deal to prevent cuts to the bond insurer's top AAA credit rating.

Ambac shares rose 15.9 per cent as S&P "affirmed" its triple A rating for now, but kept the company on review until it detailed its plans.

The monoline insurer could announce a capital raising this week but the transaction may take longer as the various parties try to agree on terms, people fam-iliar with the matter said. There was said to be a strong resolve to secure a rescue package for the insurer.

The cost of insuring against defaults on corporate debt fell in both the US and Europe yesterday. Spreads for corporate debt over the risk-free rate have risen because of worries about wind-downs of struc-tured credit products and concerns that the credit crunch will spread to the wider economy and damage non-financial com-panies.

The monoline bond insurers attracted little attention until the credit crunch but their increasingly fragile position has raised fears of a further wave of writedowns on the $2.4trn of securities they back. As the debt markets boomed, the insurers expanded from their traditional job of guaranteeing mun-icipal bonds into insuring collateralised debt obligations and other products that have been at the heart of the sub-prime crisis. A deal to shore up the insurers would involve splitting the safe municipal bonds from riskier assets. Last night, MBIA signalled it was also scrapping its dividend to conserve cash.

Most US banking shares rallied in the late afternoon as investors began to look further ahead than what is expected to be a dismal first quarter of the year. Goldman Sachs is forecasting big extra writedowns for US investment banks and another influential analyst predicted a second straight quarterly loss for Citigroup, the biggest US lender.

Goldman predicted more than $27bn of additional credit-crunch writedowns at Merrill Lynch, Citi, Leh-man Brothers, Bear Stearns, Morgan Stanley and JPMorgan. Citigroup shares closed 1.6 per cent lower after Meredith Whitney, an analyst at Oppenheimer & Co, forecast a $1.6bn loss for the first quarter of this year because of losses on sub-prime assets, leveraged loans and residential mortgages. Ms Whitney predicted a dividend cut by Citi in late October when most observers thought the payout was safe. Citi cut the dividend in January.

British banking stocks jumped as acquisition hopes increased and investors gained confidence in lend-ers' ability to weather the credit crunch. Alliance & Leicester was the biggest riser in the FTSE 100 for the second straight day, up nearly 9 per cent. Royal Bank of Scotland shares rose 5 per cent before its results on Thursday.