Sell Side

Good News For CIFG, Connie Lee

State regulators provided a boost to two insurers yesterday, as New York said it was holding off on placing CIFG into rehabilitation due in part to commutation agreements the company announced, and Wisconsin gave approval for Ambac Financial Group Inc. to reactivate insurance subsidiary Connie Lee Insurance Co.

The moves could also help municipal bond investors, with CIFG announcing it will seek a double-A or better insurer to reinsure its public finance book as part of a memorandum of understanding it signed with credit default swap counterparties and insured bondholders on its asset-backed securities and commercial real estate collateralized debt obligations.

CIFG said that its financial guaranty subsidiaries have reached agreements to commute approximately $12 billion in structured finance exposures in return for an undisclosed amount of cash and equity.

The company said the moves should improve its capital position and claims paying ability to levels "sufficient to satisfy rating agency investment grade capital requirements." Even though CIFG's has statutory filings "indicating insolvency," a spokesman for theNew York State Insurance Department said the agency will temporarily forebear on placing the insurer into rehabilitation.

"The forebearance is based on the MOU and other actions, which provide the opportunity for CIFG to resolve its insolvency and is conditioned on further prompt progress in solidifying the transactions, especially reinsuring the municipal bond business," spokesman David Neustadt said. "However, for that to happen, much remains to be done. The department will continue to work closely with the company to ensure a timely outcome that is in the best interest of policyholders."

The announcement comes less than a week after MBIA Inc. won the department's auction and took on $184 billion of Financial Guaranty Insurance Corp.'s public finance book in return for $741 million in net unearned premiums. Under that unique "cut-through" reinsurance arrangement, policyholders will be able to take claims to either MBIA or FGIC.

New York insurance commissioner Eric Dinallo said CIFG was the department's top priority following that deal. In previous comments, he had said both CIFG and FGIC were in binary positions: they needed to either make deals with counterparties or face insolvency. FGIC also announced it had commuted $1.875 billion in structured finance exposure in a deal with Calyon, a French bank.

Last week's deal appeared to benefit all parties. MBIA saw its stock jump to $16.15 per share the day after the sale from $11.98 per share the day of it. FGIC released capital it can now use to make other settlements with other structured finance counterparties.

Municipal policyholders could benefit, too. Dinallo said bonds backed by the junk-status rated FGIC could receive the double-A rating of MBIA. Although many bonds already trade at their underlying ratings value in the secondary market, the deal could provide at least a little reassurance, some market participants said.

"Prior to FGIC's current problems, it was Cumberland Advisors' opinion that FGIC insured municipal bonds to the most stringent credit standards of the AAA bond insurers," portfolio manager John Mousseau wrote yesterday in a report about the FGIC deal. "The downgrade of FGIC has left a number of very good underlying credits trading very poorly because of the 'FGIC-insured' sign on the front of the bonds. This should be one step in reversing some of this fall-off."

The market also got one step closer to adding another insurer yesterday, as Wisconsin insurance commissioner Sean Dilweg approved Ambac's plan to reactivate its insurance subsidiary, Connie Lee Insurance Co.

Although Connie Lee would still need to receive top ratings before it could do business, the announcement bolstered Ambac's plan to recapitalize the insurer with $850 million, a move it has discussed for months. Ambac said it is working with Moody's Investors Service and Standard & Poor's to obtain stand-alone triple-A ratings for Connie Lee and expects the subsidiary will write new insurance policies no later than the fourth quarter.

"We have been closely working with Ambac and others to address some of the unfulfilled needs in the financial guaranty markets resulting from the sub-prime lending crisis and related uncertainties in the financial sector," Dilweg said in a statement. "There is clearly a need for new players in the market. Ambac's strategy to reactivate its subsidiary Connie Lee is one way to provide additional insurance capacity in the municipal bond markets."

Ambac also announced executive vice president and chairman and chief executive officer of Ambac Assurance UK Ltd. Douglas Renfield-Miller as chief executive officer designate for Connie Lee. In addition, Judy Slotkin - who has served as head of credit for Citi's public finance business - will join Connie Lee as chief risk officer. Ambac will begin transferring underwriting, management, and support staff to Connie Lee over the next few months, although Connie Lee will operate as a separate corporate and legal entity.

Ambac purchased Connie Lee in 1997, a few months after the quasi-public entity, which focused on wrapping low investment-grade health care and education credits, went private. Connie Lee's insurance portfolio has $650 million in exposure outstanding, mostly on credits it considers low risk, and holds no loss reserves, Ambac said in a second-quarter earnings call last month.

"Connie Lee will help carry forward the successful franchise Ambac has built up over 37 years while addressing rating agency concerns regarding business production," said Michael Callen, chairman and chief executive officer of Ambac, in a statement. "This is an important element in our strategy to restore Ambac Assurance's own triple-A ratings and create value for our shareholders."

Although insurance penetration has fallen to less than 10% in recent weeks, market participants have told Moody's that insurance penetration could revert back to as high as 35% of the market if muni-only, triple-A insurers were available to issuers and investors. The rating agency also said in a report last month that a muni-only insurer would have a better chance of receiving a triple-A rating than an insurer that also backed structured finance products.

Others, however, have cast doubts on the plan. In an August research report, JPMorgan's Andrew Wessel downgraded Ambac, calling its business model "broken." Even if Connie Lee gets a triple-A rating, he said its return potential will be "unappealing."

In his hypothetical scenario, it would take Connie Lee more than a decade to generate a return on equity in the low double-digits. He did not consider investment income that Connie Lee might earn as having a new benefit for Ambac, as Ambac will contribute much of the capital, so it could have earned that anyway.

Also, he wrote that if a muni-only subsidiary gets a triple-A credit rating, it's likely other insurers, including Assured Guaranty Corp. and Financial Security Assurance Inc., would follow suit, adding competitive pressure to the public finance insurance market.

MBIA Inc. has also considered plans to recapitalize a muni-only subsidiary. Its own decision would hinge on if it could get triple-A ratings and a rate of return on its equity it could justify to shareholders, chairman and chief executive Jay Brown said in a conference call with investors last month. He said it could be months before it gets the answers to those questions.

"While we expect to return to credit enhancement business in the future, there is no reasonable basis for estimating when that might occur," Brown said.

Ambac, however, appears confident about its chances. Callen last month said in a conference call with investors that receiving a triple-A from ratings agencies is the largest hurdle, but that market acceptance would not be an issue. Robert Shoback, director of public finance, said initial meetings with institutional investors and issuers had been positive.

"The need is still great, there is a huge imbalance between supply and demand," Shoback said during the conference call. "And the investors, the issuers, they want this product."


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