N.Y. Regulator to Weigh Split of FGIC’s Bond Insurance Business

By | February 19, 2008

New York regulators are eager to consider splitting Financial Guaranty Insurance Co.’s core bond insurance businesses to protect municipal credit ratings against costly downgrades and stem troubles in the debt markets.

Last Friday, FGIC said would like to organize a new domestic financial guarantee insurer in New York to “provide support for public finance obligations previously insured by FGIC.”

Analysts said other bond insurers are likely to make similar moves to split their exposure to riskier financial instruments.

“Other bond insurers will be tempted to follow suit, especially the ones that have already been downgraded by at least one ratings agency,” said Donald Light, a senior analyst at Celent of Boston, a financial research and consulting firm.

State Insurance Superintendent Eric Dinallo, who has spoken sympathetically about FGIC’s need for a split of its municipal insurance business, said he hopes that won’t happen to other mortgage insurers.

He said talks are going well with the other bond insurers, including MBIA Inc. and Ambac Financial Group Inc.

“There’s a lot of interest and they’re just going to have to figure out how to economically execute on it,” he said. “But I think there’s a much higher degree of optimism on those two companies.”

Dinallo said rating agencies have given bond insurers a week or two to strike a deal.

Bond insurers have struggled in recent months as ratings agencies have worried the companies would not have enough capital to cover a potential spike in claims. Ratings agencies are worried rising delinquencies and defaults on mortgages will lead to an increase in defaults among bonds backed by the troubled loans.

That in turn would force insurers to pay out claims. Bond insurers pay principal and interest when issuers fail to make payments.

A ratings downgrade would make it more expensive for cities and towns to borrow money.

Last Thursday, FGIC’s critical financial strength rating was cut by Moody’s to “A3” from “AAA.” Bond insurers essentially need a “AAA” rating to book new business. Moody’s said FGIC needs access to $9 billion to maintain the “AAA” rating, but the company currently has access to just $5 billion.

Standard and Poor’s and Fitch Ratings had previously downgraded FGIC.

In its statement Friday, FGIC said it has been exploring various capital raising and other initiatives over the past several months.

“After careful consideration, the company has informed the New York state Insurance Department that it would like to begin the process of organizing a new domestic financial guarantee insurer in New York,” the statement said.

“Once licensed, this new insurer would be used to provide support for public finance obligations previously insured by FGIC and to write new business to serve the municipal markets,” the company said.

Dinallo said that “without capital infusions this probably is the necessary outcome” for FGIC.

“That’s sort of the endgame if we can’t get capital infusions into these companies,” he said.

Dinallo said word that FGIC may split its businesses stops the clock on any more downgrades. He said a decision on whether the split will be allowed will take weeks because of the complexity of creating the application and then reviewing it.

A day after he and other state officials testified at a congressional hearing on the bond insurers, Dinallo said the message from Congress was, “If you can solve it, solve it, but don’t let the municipalities downgrade.”

The insurance department has been working in recent months with bond insurers and banks to figure out ways to help the insurers maintain their “AAA” ratings and ensure their viability.

“I think it’s just important that we demonstrate, or the company at least tries to demonstrate, there is a plan, that we have the capacity to save the ratings on the municipal side of the books,” Dinallo said. “We want a private side solution that injects capital into these companies … but failing that, we can’t let the municipalities downgrade.”

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Associated Press Writer Michael Hill in Albany and Business Writer Stephen Bernard in New York City contributed to this report.

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