UPDATE 4-NY court tosses challenge to MBIA restructuring

* Divided court dismisses banks' lawsuit

* Banks filed suit in 2009 amid concerns on claims

* Separate proceeding challenging plan moves ahead

* MBIA stock rises to highest since September 2008 (Adds comment, background on trial schedule; updates shares)

By Ben Berkowitz

NEW YORK, Jan 11 (Reuters) - Bond insurer MBIA Inc (MBI.N) won a crucial victory in the legal battle over its restructuring on Tuesday as a New York state appeals court dismissed a challenge to the plan by a group of banks.

MBIA shares closed up 10.2 percent following the decision, which reversed a lower-court ruling, after earlier touching their highest level in more than two years. The shares of mortgage insurers also closed higher.

The 3-2 decision could remove a major threat to MBIA's restructuring, which is designed to protect the company's municipal bond business from the risks attached to its structured finance unit. It will be appealed automatically to the state's highest court.

Bond insurers such as MBIA and Ambac Financial Services Group Inc (ABKFQ.PK) once confined themselves to writing protection on bonds issued by local governments before branching out in the last decade into providing insurance for exotic financial products.

They got into trouble during the credit crisis when losses on those products ballooned. Ambac, once second globally to MBIA in bond insurance, filed for bankruptcy protection last November. [ID:nN08157747]

Seeking to avoid a possible bankruptcy filing of its own, MBIA restructured in 2009 under the supervision of Eric Dinallo, New York's insurance superintendent at the time, splitting its municipal bond business from its structured finance operations.

A group of banks sued MBIA in state court, arguing the split left its MBIA Insurance Corp unit undercapitalized and potentially unable to pay out on their claims.

MBIA argued the banks should have challenged the restructuring in a separate action under New York law known as an "Article 78" proceeding since the plan was carried out under regulatory supervision.

A lower court in early 2010 denied MBIA's motion to dismiss the banks' lawsuit, but Tuesday's ruling grants that motion.

"We view this news positively, as it allows MBIA to separate into a municipal guaranty only unit, separate from the troubled structured finance unit," Standard & Poor's insurance equity analyst Cathy Seifert wrote in a note.

She nonetheless downgraded the stock to "sell," saying it was trading at an unwarranted premium relative to peers.

NO DATE SET

Tuesday's ruling will be reviewed by the New York State Court of Appeals, the state's highest court.

"As powerfully demonstrated in the dissent, the majority opinion is wrong on the law and ignores the allegations of the complaint," Robert Giuffra, a lawyer for the banks, said in a statement.

The court had not yet set even a tentative trial date for the banks' suit against MBIA, the company said.

The banks have also initiated the Article 78 proceeding, which is pending. MBIA said in a regulatory filing in late December that case was not likely to be heard before the second quarter of this year.

A number of banks have recently dropped out of that Article 78 case, including JPMorgan Chase & Co (JPM.N) and Barclays Plc (BARC.L). [ID:nN29287934]

"We are gratified by the Appellate Division's decision and are now looking forward to a prompt resolution of the Article 78 proceeding, in which we fully expect to prevail," MBIA CEO Jay Brown said in a statement.

The New York Insurance Department declined comment.

Representatives from Citigroup Inc (C.N), HSBC Holdings Plc (HSBA.L) and ABN AMRO Bank NV [ABRGPA.UL] declined to comment. Morgan Stanley (MS.N) was not immediately available. The four are among the largest banks still party to the suit.

MBIA shares closed at $13.53. Earlier in the session they hit $14.86, their highest since September 2008.

Shares in other mortgage insurers rallied as well, with PMI Group Inc PMI.N up 3.6 percent and Radian Group Inc (RDN.N) closing 5.4 percent higher.

The case is MBIA Inc et al v. ABN Amro Bank NV et al, New York State Supreme Court, Appellate Division (1st Dep't), Nos. 3123, 3124, 3124A. (Reporting by Ben Berkowitz; additional reporting by Jonathan Stempel and Maria Aspan in New York and Tom Hals in Wilmington, Delaware; editing by Andre Grenon and John Wallace)