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Ambac Rolls Monorail Dice in Las Vegas

Ambac Financial is arguing in court that the Las Vegas Monorail Company shouldn't be able to seek Chapter 11 bankruptcy protection, and a Nevada judge is expected to rule next week.
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) -- Struggling bond insurer



went to the U.S. Bankruptcy Court of the District of Nevada on Wednesday to ask that the judge declare that the

Las Vegas Monorail Company

, or LVMC, is ineligible for a Chapter 11 bankruptcy.

Ambac is also arguing that Las Vegas Monorail acted illegally in operating a

Bank of America

(BAC) - Get Bank of America Corp Report


The monorail which transports passengers to and from the Bally's and MGM Grand hotel-casinos picks up passengers outside the MGM Grand in Las Vegas.

U.S. Bankruptcy Judge Bruce Markell is expected to rule towards the end of next week. He gave no indication as to how he might rule. William P. Smith, a partner in the Chicago offices of McDermott Will & Emery LLP, represented Ambac. He said that the judge was "interested and engaged" and that he is "confident that the judge understood the issues and am cautiously optimistic that he will find in our favor."

The case has high stakes as Ambac has a potential $1.1 billion liability in bond guarantees. Wells Fargo

(WFC) - Get Wells Fargo & Company Report

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is the LVMC trustee. Bank of America is sitting on all the cash but has no other interest in the case.

In a session that lasted over ten hours, Smith contended that LVMC is ineligible for a Chapter 11 bankruptcy.

This is primarily because Ambac contends that LVMC is an "instrumentality of the state", in other words a state agency, as declared in the 2000 tax certificate and agreement between the Director of the State of Nevada Department of Business and Industry and LVMC.

Arguments focused on the nature of the company under this definition with Smith arguing for Ambac that you cannot elect to be an instrumentality for tax purposes and not for others.

The State of Nevada supports the position taken by LVMC. In an interview, with

, Smith expressed that he was "surprised that the state took a position and is backing away from the position at the time the bond was issued."

Whether the judge rules for Ambac or not on the bankruptcy issue, it does not change the substance of the $1.1 billion liability, according to Ambac's lawyer. The point is how the debt would be worked out. Chapter 9 would provide the creditors and Ambac more control over the assets and cash flows.

It was these assets that were the subject of the afternoon arguments. Ambac's laywer maintains that this is a "manufactured crisis," arguing that the train is running up and down the track and that it is generating revenues in excess of the operational expenses.

According to Smith, there is $2 million in the BOA account and less than $20,000 in the Wells Fargo account. Wells Fargo and Ambac maintain that all proceeds from train operations are supposed to be placed into the trustee account and that LVMC continues to siphon the cash directly from the trains into the BOA account, even in bankruptcy.

This is important because the trustee and Ambac argue they have liens and control over all the cash collateral that passes through the Wells Fargo account and that the cash in the BOA account is in jeopardy.

Wells Fargo and Ambac are asking the judge to agree that the opening and operating of the BOA account was in breach of the financing agreement. They want orders granted regards the contents of the account and future revenues in favor of the trustee.

Control over the cash generated by the LVMC is at the core of the bankruptcy petition. Both Ambac and the trustee object to unnecessary expenses, such as trips to China taken by the LVMC CEO, directors monthly fees of $5,000 and the hiring of a lobbyist. The trustee has to approve expenditures and Ambac wants it that way.

Ambac claims that more than $3.3 million went through the BOA account prior to the bankruptcy filing and that these monies could have been used to mitigate the $16.8 million paid out by Ambac. Any reduction in the amounts paid by Ambac would, of course, help the insurer.

Ultimately, fortunately for Ambac, there are no early payment event triggers and so the effect of any losses and the impact on cash flow will be spread over 40 years. No matter the decision, the LVMC will be making the July interest payment of around $9.5 million on the Tier 1 bonds, according to Smith.

The risk for Ambac on this Las Vegas trip is very low; the odds are good and the potential gain is substantial over a period of years. It will be hoping that what happens in Vegas doesn't stay there.

The stock rose 18%, or 11 cents, to 71 cents on Wednesday as volume grew and rumors of a potential settlement swirled. Shares were dropping back in early trading Thursday, losing 8%, or 6 cents, to 65 cents.

Reported by Gavin Magor in Jupiter, Fla.

Gavin Magor is the senior analyst responsible for assigning financial-strength ratings to insurance companies. He conducts industry analysis and supports consumer products. Magor has more than 22 years of international experience in operations and credit-risk management, commercial lending and analysis. His experience includes international assignments in Sweden, Mexico, Brazil and the U.S. He holds a master's degree in business administration from The Open University in the U.K.