* New company includes FGIC portfolio
* MBIA downgraded to below investment grade
* Shares up 31 percent (Adds analyst comment, Moody’s downgrade, credit default swap levels, updates stock)
By Elinor Comlay
NEW YORK, Feb 18 (Reuters) - MBIA Inc (MBI.N), the world’s largest bond insurer, is separating its municipal bond operations into a new unit as it looks to rebuild a business shattered by the subprime mortgage crisis.
The plan met with mixed reaction on Wednesday. Because the unit could win new business for MBIA, shareholders cheered the move and sent the company’s shares up 31 percent in afternoon trading.
But rating agencies Standard & Poor’s and Moody’s Investors Service downgraded the company’s main insurance unit. S&P also rated the new unit “AA minus,” or the fourth highest level, while Moody’s rated it “Baa1,” the eighth highest level, and said it may upgrade it.
The new unit, National Public Finance Guarantee Corp, which has a separate rating, launches in an increasingly difficult period in the world of municipal finance. Cities and states are struggling with lower tax receipts as property markets, and the overall economy, crater.
Concern about issuers would typically boost demand for bond insurance, but investors are also concerned about the stability of the insurers.
Still, MBIA Chief Executive Jay Brown told Reuters he is confident that National Public Finance will win business and improve its ratings over time.
“We think the U.S. muni market is here forever, and we will do this at our own pace,” Brown said. The unit will look to raise capital, but will not rush, he added.
MBIA lost its top credit ratings last year after a disastrous foray into guaranteeing repackaged debt instruments triggered massive paper losses and large payouts for the insurer.
But moving its municipal business into a separate operation could also help the repackaged debt business, known as structured finance, by clarifying exactly how much capital is available for it, Brown said.
Brown said in a letter to shareholders that the company has stopped using credit derivatives, which MBIA employed to guarantee many structured finance instruments, because their price fluctuations had a dire impact on the company’s financial statements.
Eric Dinallo, superintendent of the New York Insurance Department, said MBIA’s strategy of splitting the public and structured finance businesses may be applicable to other bond insurers
“It may be a template,” Dinallo said. He also hopes MBIA’s return to public bond markets will help bond issuers by increasing price competition.
The insurers’ straits last year reduced demand for insured municipal debt by 64 percent as investors grew wary of the bond insurers, analysts said.
But if MBIA can raise S&P’s rating on its new unit one notch to “double A,” it should find ample demand for municipal insurance, said Gary Ransom, an analyst at Fox-Pitt, Kelton.
“There’s definitely demand,” he said, but explained that issuers would likely want to see a stable rating without the “minus.”
Only about 13 percent of all new municipal bonds now are insured, down from the traditional 50 percent level that prevailed for years.
The new public finance company will have an initial portfolio of $537 billion in U.S. public finance business, taken from MBIA’s existing business. That will include the public bond business of Financial Guaranty Insurance Co, a separate bond insurer, that MBIA reinsured in August.
MBIA said its main insurance unit paid the new unit $2.89 billion to reinsure the public bond policies. MBIA Inc, the holding company, will capitalize the new unit with $2.09 billion.
But partly because MBIA’s main existing insurance unit, MBIA Insurance Corp, will receive fewer premiums under the deal, Moody’s downgraded it eight notches to “B3”, or junk status. S&P cut it five notches to “BBB-plus” from “AA.”
The rating agencies also warned of further losses to come from the repackaged debt in the structured finance book, although Brown said in his letter that MBIA can pay all expected claims in the future, “even under severe global economic conditions like we are currently experiencing.”
Ambac Financial Group Inc ABK.N, another major bond insurer that has been downgraded, is also seeking to revive its business by reactivating a unit called Connie Lee as a new municipal bond insurer.
MBIA shares were up $1.09 at $4.57 on the New York Stock Exchange after rising as high as $4.92 earlier in the session.
The cost of insuring MBIA debt soared in response to the rating downgrades to about $5.6 million per year to insure $10 million for five years, from about $3.5 million a year. (Reporting by Elinor Comlay, additional reporting by Dan Wilchins, Lisa Lambert, Joan Gralla and Karen Pierog; editing by John Wallace and Jeffrey Benkoe)