Bond Insurer FGIC Downgraded Again, Seeks To Split–Litigation Likely To Follow

 

Moody’s Investors Service downgraded the insurance units of FGIC Corp., the fourth-largest bond insurer, six levels from Aaa to A3 and announced that further downgrades were possible. This downgrade occurred as a result of FGIC’s expansion into guaranteeing CDOs backed, in part, by subprime mortgages. FGIC, which is owned by Cypress Group, PMI Group, Inc. and Blackstone Group LP, had its rating cut eight levels to below investment grade.

As a result of Moody’s downgrade, the New York Insurance Department has reported that FGIC is seeking to be split in two to protect the municipal bonds it insures from the problems attributable to its guarantees of subprime-related securities. Essentially, FGIC is seeking to separate its “good” business (insuring municipal bonds) from its “bad” business (insuring subprime structured finance products.) FGIC reportedly insures $220 billion of municipal bonds and another $94 billion of other debt.

As reported in Bloomberg.com, Bank of America analysts believe that the attempted split may spawn “years of litigation.” Analyst Jeffrey Rosenberg noted that “Despite the regulatory interest in separating the exposures, the essential fact remains that all policy holders, whether municipal or structured finance, entered into contracts backed by the entire entity … [and the breakup is] likely to lead to significant legal challenges…”

Recent downgrades of FGIC and Ambac, along with possible downgrades of other leading bond insurers, have caused fear regarding the ratings of bonds issued by thousands of municipalities around the country. Such bonds carry the rating of the bond insurer unless the issuing entity (municipality) carries a higher rating on its own. Thus, the downgrade of a bond insurer can impact the ratings of literally thousands of the bonds that the insurer has insured.