The crisis sweeping the bond insurance industry escalated yesterday as America’s second-biggest bond insurer effectively began to wind itself down by cancelling a plan to raise $1 billion (£511 million) of new capital in a move that sacrificed its AAA credit rating.

Ambac’s decision to scrap the new share offering, combined with Fitch’s two-notch downgrade to AA, provided further evidence that the market had lost a huge amount of confidence in the bond insurers, which guarantee to repay the interest and principal on securities that they underwrite in the event of a default.

Shares in Ambac, MBIA, ACA and other bond insurers have plummeted recently as the jump in defaults on American mortgages has left them facing such enormous claims on securities backed by home loans that their ability to honour them has been called into question.

Ambac cancelled its fundraising yesterday after a 70 per cent decline in its shares in the previous two days. The insurer had planned the capital raising in a last-ditch attempt to maintain the AAA rating that is crucial to winning new business.

However, in a sign of just how little confidence the market has in the ability of insurers to meet their obligations, the group decided the AAA was not worth fighting for anyway.

Ambac made its announcement soon after Tamara Kravec, an analyst for Bank of America, issued a note saying: “We believe the bond insurers are better off not raising capital, given that capital-raising to preserve the rating is extremely dilutive and the triple-A rating is essentially worthless in the current environment.”

That note came a day after Andrew Moloff, the chief investment officer of Evercore Asset Management, an Ambac shareholder, urged Ambac to shelve the plan, concede the AAA rating and allow its existing insurance policies to “run off”.

Sean Egan, of Egan-Jones, a credit research agency, said: “It is reasonable to draw the conclusion that Ambac is either winding down its operation, or hoping to get bought. It needs a massive influx of capital and this just means that the slide will accelerate, with cataclysmic results for the bond industry and beyond.”

Just hours after Ambac scrapped its fundraising, Fitch removed the insurer’s AAA rating. The cut means that cities will find it more difficult to issue new bonds because of the scarcity of insurers willing to underwrite the risk.

Moody’s said yesterday that it was placing MBIA on credit watch for a possible downgrade of its AAA status. Ambac’s decision sent its shares up for most of the day, as investors celebrated the fact that their holding would not be diluted by the issue of new shares. However, they ended down slightly, at $6.20, a loss of four cents. Ambac’s shares, which lost 76 per cent of their value last year, began to slide on Wednesday after a jump in the payouts it expected to make forced it to issue a profit warning. The company also ousted its chief executive, cut its dividend by two thirds and announced plans to raise $1 billion of new capital.

Robert Genader, 60, resigned immediately as chairman and chief executive on Wednesday. Michael Callen, 67, a board member and former Citigroup executive, became chairman and interim chief executive.

The quarterly dividend cut was from 21 cents a share to 7 cents.

Insurers left reeling

Wall Street banks often hedge the risk of their mortgage bond investments by using credit default swaps. This is an insurance policy, whereby the holder of the swap makes an annual payment in return for a guarantee that the insurer will pay up if the bond defaults. However, the continued deterioration of America’s housing market has left insurers facing such large claims that they may not be able to meet all their obligations.

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