Sell Side

Inside the FGIC-MBIA Auction Pact

Before Financial Guaranty Insurance Co. agreed to have MBIA Inc. reinsure $184 billion of its public finance portfolio, it initially selected Assured Guaranty Ltd. as the winner of its auction to take on the book, according to documents FGIC filed with the New York Insurance Department earlier this month.

FGIC asked MBIA if it was still interested in bidding on the deal after the auction had concluded, in part due to concerns from the department about the initial winning bid, the documents say. Although they do not name Assured, they single it out by mentioning the winning bidder had its stock negatively impacted by Moody's Investors Service's decision to put its rating on watch July 21. Moody's took action on Assured and Financial Security Assurance Inc. that day, and only Assured is publicly traded.

The documents FGIC filed in coordination with its bid include an affidavit signed by an executive vice president and chief risk officer, a letter from Goldman, Sachs & Co., and a solvency opinion made by Bridge Associates LLC. Together, they describe the process that began last October as FGIC attempted to deal with the fallout from the credit crisis.


Once one of the top three municipal insurers, FGIC last year saw its financial position begin to deteriorate due to exposures to the housing market through guarantees on structured finance products. At the end of 2006, it had just $28.2 million in statutory loss and loss expense reserves. That number reached $1.95 billion by the end of 2007.

Under pressure, FGIC last October hired Goldman Sachs to explore a number of strategic options, including a capital raise, a sale or merger of FGIC or its parts, a reinsurance transaction, and a cessation of writing new business. FGIC in December hired Blackstone Advisory Services LP as a financial adviser for restructuring activity. Blackstone's parent - the Blackstone Group LP - owns part of FGIC through one of its affiliates.

By January, regulators got involved. New York Insurance Department superintendent Eric Dinallo convened a meeting Jan. 23 between FGIC and six of its counterparties to discuss the insurer's financial position and any restructuring efforts. BNP Paribas, Calyon, Citi, HSBC Bank NA, Societe Generale, and UBS Securities LLC all attended.

Soon after the meeting, the eight counterparties formed a committee and hired law firm Paul, Weiss, Rifkind, Wharton & Garrison LLP to act as counsel. FGIC has so far paid for the law firm and its financial advisers - Goldin Associates and Hyperion Brookfield Asset Management Inc. - at a cost of $4.3 million. During this time FGIC also held discussions with lenders of its revolving credit facility, which included some counterparties.

On March 28, the New York Insurance Department sent a letter laying out a timeline that gave FGIC a month to show it the first round of proposals from interested investors. The department focused it efforts during the auction on providing guidance on what it would approve and on keeping the process on schedule, officials said.

"We basically said look, your financial condition is deteriorating ... we're frankly kind of getting worried about what happens to insurance, particularly the public finance credits," said Hampton Finer, deputy superintendent and chief economist. Later he added: "We basically said, 'What is your plan for protecting the insurance of these guys? We don't want the money going out the door to the structured credits, etc.' "

Goldman and FGIC contacted 57 potential investors about submitting plans, and 32 parties signed confidentiality agreements, including the eight counterparties, to view documents relating to FGIC's financial health and portfolio. Eleven potential partners, reinsurers, and private equity firms eventually submitted bids. None of the counterparties submitted bids, but they continued to negotiate with FGIC on an alternate proposal.

Bidders proposed a number of different transactions, including a capital infusion, a reinsurance agreement, the capitalization of a new insurer together with a reinsurance deal, and the purchase of remaining assets after a recapitalization and reinsurance pact. Most if not all of the reinsurance bids included negative ceding premiums, in which FGIC would need to pay to the bidder in excess of the premiums to transfer the policies, according to Finer.

"We were a bit concerned about whether that would really be fair to the other policyholders," Finer said.

Seven groups submitted proposals during the second round of bidding, which ended May 22. After reviewing the results - which were similar in scope to the initial 11 bids - FGIC asked four firms for their final proposals.


On June 11, FGIC received the final bids. It selected one from Assured Guaranty as its top choice less than two weeks later.

To allow for further due diligence and negotiation, FGIC signed an exclusivity agreement with Assured that expired July 16. The proposed deal allowed FGIC to continue talks with its counterparties - who had also submitted a proposal - after that point. In addition, FGIC could opt out of its deal with Assured within 30 days of the execution of the transaction documents at a cost of $10 million if it believed the counterparty bid was superior.

When Moody's placed Assured's Aaa rating on review for downgrade July 22, the sides had yet to finalize a deal. Although the announcement had a negative impact on financing condition in the bid, Assured and FGIC met with the New York Insurance Department a week later to say they planned to continue with it.

The department, though, urged FGIC to reconsider its position, voicing concerns about the financing condition in the deal, and Assured's unwillingness to provide the type of cut-through insurance officials wanted, according to the documents. The department also questioned the opt-out proposal for the counterparty bid.

Assured Guaranty chief executive officer Dominic Frederico did not discuss the meeting, but said in an interview that throughout the process the Insurance Department made suggestions about what Assured should consider without ever making any specific demands for completing the deal. This squared with the New York agency's goal and responsibility of getting the best deal they could, he said.

"We were always told 'Could you look at this issue again or could you look at that issue?' " Frederico said. "But conceptually we always have to do what we think is right for our company, which looks at return, legally liability, and other issues that could affect performance, such as this cut-through."

Following the meeting, FGIC contacted MBIA to see if it was still interested in the transaction, while also continuing to work with the counterparties. FGIC and Goldman Sachs negotiated with both MBIA and Assured until they resubmitted their proposals on August 18.

Two days later, FGIC selected MBIA's bid. A week later, the firms approved and announced it.

Under the ultimate terms of the deal, MBIA will provide cut-through reinsurance for $184 billion of FGIC's $200 billion U.S. public finance book. It will receive net premiums worth $741 million after paying a ceding commission of 21% to FGIC. MBIA will not reinsure certain below-investment-grade municipal credits, FGIC's $21 billion international book, or its $64 billion structured finance portfolio.

The Insurance Department considered MBIA's essentially no-conditions offer of cut-through reinsurance as a key selling point for the deal. Because bondholders can go to either MBIA or FGIC with a claim, New York officials believe the rating agencies may choose to rate the credits backed by FGIC at MBIA's level.


But Assured said the cut-through reinsurance it agreed to provide - which allowed policyholders to come directly to Assured in the event of FGIC's insolvency - would still have given the bondholders coverage from a top-rated company with a stable capital base. The condition that the cut-through insurance wouldn't have applied if FGIC refused to pay a claim "really shouldn't have mattered," according to Frederico.

"We believe that we had the best deal on the table depending on what the purpose was," he said. "If the purpose is truly to further protect bondholders and people that have an insurance policy from FGIC, we still think our deal was wholly superior relative to the protection of the fixed-income investors and the guarantees they hold."

In the affidavit, FGIC said the MBIA deal "was the superior proposal in terms of enhancing FGIC's capital position and protecting its policyholders." Despite its recommendations, the department says FGIC made the final decision on its own.

"The Insurance Department did not choose MBIA, in no uncertain terms," Finer said. "We obviously expressed concerns with both of the bids as they were going on, but ultimately FGIC made the decision, obviously taking into account what was approvable."

MBIA says the deal will benefit its return on equity as the premiums become earned over the terms of the policies. FGIC can release contingency reserves tied to the policies and gets to keep a ceding premium, which it can use to commute other guarantees. It has already agreed to pay Calyon $200 million to settle an exposure to $1.875 billion of asset-backed securities.

FGIC expects it statutory surplus will increase to $853.4 million on Sept. 30 from $285.6 million on June 30 following the deals. Its total qualified statutory surplus, which includes contingency reserves, increases to just over $1 billion from $731.6 million. FGIC likely would have become insolvent without the deal, Finer said.

The New York Insurance Department said it will serve a similar role as CIFG Assurance NA looks to reinsure its own portfolio. Officials said the timeline for a resolution of that agreement is "relatively short."

"We're obviously very involved again, but ultimately CIFG will make the decision based on behalf of what's best for the insurance company," Finer said. "That's something we don't anticipate having any significant role in determining at the end of the day, although we certainly have strong feelings about the type of transaction that's acceptable to us."





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