NEW YORK (Bloomberg) - Forewarned bankruptcies linked to infrastructure projects from Las Vegas to Harrisburg, Pennsylvania, may prove Warren Buffett's conclusion that insuring municipal bonds is a "dangerous business".

Ambac Financial Group Inc., the second biggest bond insurer, faces as much as $1.2 billion in claims if a judge in Nevada allows Las Vegas Monorail Co., which runs a train connecting the city's casinos, to reorganise in Chapter 11 bankruptcy. The City Council of Pennsylvania's state capital shelved a plan to sell taxpayer-owned assets to meet payments on $288 million of debt used for an incinerator funded in part with bonds insured by a unit of Bermuda-based Assured Guaranty Ltd. Harrisburg is weighing a possible bankruptcy filing.

With state tax collections last year through September showing the biggest drop since at least 1963, as measured by the Nelson A. Rockefeller Institute of Government in Albany, New York, local governments are seeking concessions from creditors of public projects, including bond insurers. The moves further threaten companies backing $1.16 trillion of public debt that already face $11.6 billion of claims on collapsed securities backed by mortgages.

"It is a worst-case scenario if the dynamics of the municipal bond market change," said Rob Haines, an analyst who covers the bond insurance business at CreditSights Inc., an independent research firm in New York. "The companies have modeled in virtually no losses."

Ambac, MBIA Inc. and Assured Guaranty, the three largest bond insurers, have set aside 0.04 percent of the total public finance debt they insure, or $520 million, to pay claims on municipal securities, according to regulatory filings by the companies.

Local governments are struggling with depressed property values and sales, 9.7 percent unemployment and a slowdown in consumer spending that has cut tax revenue.

Last year, 183 tax-exempt issuers defaulted on $6.35 billion of securities, according to Miami Lakes, Florida-based Distressed Debt Securities Newsletter. That is up from 2008, when 162 municipal borrowers failed to meet obligations on $8.15 billion of debt. In 2007, 31 of them defaulted on $348 million of bonds.

"In the past, things had a way of getting worked out," said Jim Ryan, an insurance analyst with Morningstar Inc. in Chicago. "States might have stepped up and helped out, but bottom line is that the states are in trouble."

Ambac sold the industry's first insurance policy on municipal debt in 1971, for a $650,000 bond of the Greater Juneau Borough Medical Arts Building in Alaska. The business thrived, with a handful of companies obtaining the top AAA credit rating needed to guarantee debt of state and local governments and their agencies that seldom defaulted. About 8.5 percent of the market for new municipal debt was insured in 2009, down from 55 percent in 2005, according to Thomson Reuters.

For more than three decades bond insurers paid few claims, allowing them to back bond payments that were 140 times their assets. Insurers described their business as one of "zero-loss underwriting," meaning that each guarantee was expected to result in no claims under the worst probable scenario envisioned by their models.

That track record was shattered when credit markets seized up during the worst credit crunch since the Great Depression. After rating companies warned they might strip bond insurers of their top rankings in late 2007, some companies averted a takeover by regulators by tearing up contracts on their worst- performing structured finance securities and freeing up reserves against those contracts.

Rising municipal claims may deplete the remaining regulatory capital of some bond insurers and speed intervention by regulators, said Haines of CreditSights.

Any regulatory takeover may trigger termination payments on billions of dollars of credit default contracts written by the bond insurers, a scenario that forced a government bailout of American International Group Inc. in September 2008.

David Neustadt, a spokesman for the New York State Insurance Department, didn't respond to a request for comment.

Ambac shares have lost 99 percent of their value from a high in May 2007 on speculation the company's capital will be overwhelmed by claims on mortgage securities.

Even as losses surged on the structured finance side of the business, Assured Guaranty and MBIA have said they still have a future backing municipal bonds.

The 3.9-mile (6.3-kilometre) Las Vegas Monorail, which opened in 2004, runs between the MGM Grand and the Sahara hotels, making five stops in between.

A developer sold 7.375 percent 30-year bonds in 2000 through the state to fund construction of the driverless, elevated electric train. New York-based Ambac insured $451 million of the securities. After $5 one-way fares failed to cover both operating costs and debt service, the company filed for bankruptcy protection on January 13.

Ambac submitted a motion the same day to the US Bankruptcy Court in Las Vegas challenging the petition. It said the nonprofit entity wasn't eligible for Chapter 11 and should instead file under Chapter 9, the section of the bankruptcy code pertaining to governmental bodies.

"The Las Vegas Monorail Co. cannot now disavow its status as an instrumentality of the state of Nevada subject to the control of the governor," Ambac said in its motion.

Bond insurers and holders have a history of being treated more favorably when an issuer files Chapter 9.

"Chapter 11 imposes an automatic stay and bondholders are not required to be paid," said David Dubrow, a partner in the New York office of law firm Arent Fox.

"Under Chapter 9, if you're a special revenue bondholder, you have the right to be paid during the bankruptcy case in the same manner as though there was no bankruptcy filing," he said.

Las Vegas Monorail has a franchise agreement with the county, and the Nevada governor has authority to appoint and remove board members, according to the Ambac motion.

"When we get too cute and too tricky and cloud public and private programs, no one can follow the money," Chris Giunchigliani, a Clark County commissioner, said in an interview. She has opposed efforts to extend the train to the airport in a bid to boost revenue.

The monorail bonds traded on February 16 at an average price of 34.76 cents on the dollar.

Angela Torres, a spokeswoman for Las Vegas Monorail, did not respond to a request for comment. Ambac spokesman Peter Poillon, declined to comment on the case beyond the company's motion.

"A Chapter 11 bankruptcy filing is not business as usual" in public finance, said Richard Ciccarone, chief research officer of McDonnell Investment Management, whose Oak Brook, Illinois-based firm oversees $6.8 billion of municipal debt. "This is treading on new ground."

In Harrisburg, the City Council voted down a proposal on February 13 to sell assets, including an island in the Susquehanna River, to cover debt services on bonds issued to build the incinerator, some of which are insured by Assured Guaranty's Financial Security Assurance unit.

The city guaranteed some bond payments, which total $68 million in 2010, or $4 million more than Harrisburg's entire proposed operating budget. Officials have said they may not meet the obligation.

"There has never been a default like this in Pennsylvania municipal finance history," Carol Cocheres, bond counsel for the Harrisburg Authority, told a City Council meeting on December 14. "This is all new territory."

Harrisburg was downgraded to five levels below investment grade by Moody's Investors Service on February 9. The city's general obligation bonds were cut to B2 from Ba2 and a negative outlook on the community of 47,000 was maintained.

Harrisburg Authority 5 percent bonds insured by Assured Guaranty Municipal Corp. and set to mature in 2021 traded at an average price of 98.46 cents on the dollar to yield 5.179 percent. The price reached a record low of 85.72 cents on November 12.

Battles over debt payments were anticipated by Buffett, chairman of Berkshre Hathaway Inc. The billionaire investor set up a municipal bond insurance company in December 2007, as competitors were being threatened with the loss of their top ratings.

In early 2008, Omaha, Nebraska-based Berkshire Hathaway's bid to take over $800 billion in municipal debt guarantees from the three biggest bond insurers, including Ambac, was rejected by the companies.

A year later, he reversed course, telling shareholders in his annual letter that municipal bond insurance "has the look today of a dangerous business."

"If a few communities stiff their creditors and get away with it, the chance that others will follow in their footsteps will grow," Buffett wrote. "What mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a far away bond insurer?"

Buffett didn't respond to a request for comment.

The Greenville Southern Connector toll road in South Carolina, a 16-mile, four-lane beltway near the city's Michelin & Cie. auto-tire plant, defaulted on January 1 on $200 million of bonds. Some of that project's debt was guaranteed by an insurer owned by ACA Capital Holdings, since renamed Manifold Capital Corp., according to data compiled by Bloomberg.

Connector 2000 Association 5.375 percent bonds due 2038 traded at an average price of 21.24 cents on the dollar on February 17, after reaching a record low of 18 cents in November. The price peaked in May 2007 at almost 97 cents.

ACA was the first bond insurer to collapse after a credit rating downgrade required it to post billions of dollars of collateral against collateralised debt obligations (CDOs) linked to the performance of mortgages. CDOs parcel fixed-income assets such as bonds and loans, and slice them into new securities of varying risk intended to provide higher returns than other investments of the same rating.

The toll road is considering a bankruptcy filing under either Chapter 9 or Chapter 11 to restructure debt, US Bank, the trustee, said on February 11 in a notice.

Insurers may not escape Chapter 9 bankruptcies free of pain. Vallejo, California, which filed under the provision in May 2008, is seeking to suspend principal and interest payments for three years on debt, $3.9 million of which is insured by MBIA's National Public Finance Guarantee Corp. unit.

"There is a big difference between talking about bankruptcy and filing," said Thomas McLoughlin, the chief executive officer of the unit. He said Armonk, New York-based National has yet to see a trend toward other municipalities following in Vallejo's footsteps. "Municipal bankruptcies are very time consuming and the costs often outweigh the benefits," he said.

The collapse of the bond insurers' credit ratings has left all but Assured Guaranty unable to back new bond deals. That means stressed issuers cannot turn to the bond insurers to guarantee the sale of new bonds as part of a restructuring of their debts.

"One of the unspoken benefits the bond insurers provided to the municipal bond market was access to capital to refinance bond issues that were threatening to default," Ciccarone said.

That strategy is not being used now.

"As of this time, the bond insurers have played a minimal role in the Vallejo bankruptcy process," said Joann West, a spokeswoman for Vallejo.