August 28, 2008 / 4:21 PM / 11 years ago

UPDATE 1-FGIC still faces risks despite MBIA deal -analyst

(Adds details, analyst comment)

NEW YORK, Aug 28 (Reuters) - Troubled bond insurer FGIC Corp avoided possible regulatory intervention by reinsuring its municipal bond portfolio with MBIA Inc (MBI.N), but it may still face solvency issues over the long term, according to an analyst report.

MBIA agreed on Wednesday to reinsure FGIC’s $184 billion of municipal bond risk and will receive $741 million of unearned premiums from the deal after paying FGIC a ceding fee of about $200 million. For details, click on [ID:nN27498772].

FGIC tumbled into junk territory earlier this year on concerns that it would breach minimum regulatory capital requirements and could be taken over by its regulator as losses mounted on complex mortgage-backed debt it insured.

“While the deal will boost capital supporting the remaining FGIC policy-holders, it does little to solve the company’s longer-term solvency issues,” CreditSights analyst Rob Haines said in a report issued on Thursday.

But the agreement is a positive credit development for MBIA, which lost its top ratings earlier this year due to exposure to troubled mortgage-backed debt, Haines said.

MBIA shares surged almost 35 percent on Thursday to $16.15 and debt protection costs on the holding company and the insurance arm fell.

MBIA’s credit default swaps declined 2.25 percentage points on an upfront basis to 20.75 percent, or $2.075 million to insure $10 million in debt for five years, plus annual payments of $500,000, according to CMA DataVision. [ID:nN28299466]

SUCCESSION?

Terms of the deal, known as “cut-through” reinsurance, may also mean that credit default swaps written on the debt FGIC insures will now be backed by the debt underlying MBIA’s policies.

The “cut-through” reinsurance means that a policy-holder would seek payment directly from MBIA in the event of a default, rather than approaching FGIC first.

Credit default swaps typically insure against the risk of a company defaulting on its debt. In the case of bond insurers, however, the contracts are backed by the debt the companies have written policies on.

When more than 75 percent of the debt underlying a default swap is transferred to a new company the swap also moves, or succeeds, to the new institution.

“The deal’s novel feature is the cut-through which (legal opinions withstanding) may cause a succession event in FGIC’s CDS to MBIA’s CDS,” Tim Backshall, chief strategist at Credit Derivatives Research, said on Thursday in a report.

FGIC, whose owners include PMI Group PMI.N, Blackstone Group (BX.N), Cypress Group and CIVC Partners, guaranteed about $313.9 billion of debt as of the end of 2007.

The deal with MBIA boosts FGIC’s capital levels by $1 billion. But it effectively leaves it with a massive structured portfolio and the worst of its municipal bond portfolio, including a $1.2 billion exposure to Alabama’s Jefferson County, which is considering a bankruptcy filing.

If this happens, it would be the biggest municipal bankruptcy since California’s Orange County filed in 1994.

“The deal will allow FGIC to remain technically solvent for several quarters, but we continue to expect significant deterioration of its structured book and would warn of the potential for significant losses in its public finance book as well,” Haines said.

FGIC had statutory capital of $732 million at the end of the second quarter and its claims-paying resources totaled $5.2 billion, according to Haines. (Reporting by Anastasija Johnson and Karen Brettell; Editing by Leslie Adler)

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