CHICAGO — A New York State court judge has ordered Assured Guaranty Corp. to honor coverage of $83.3 million of Iowa’s Xenia Rural Water District bonds as part of its 2009 reinsurance agreement with CIFG Assurance North America Inc.
New York County Supreme Court Judge Barbara Kapnick issued a summary judgment dated Tuesday on the claims CIFG asserted in its breach of contract lawsuit against Assured and counterclaims over whether the CIFG policy covering the 2006 bonds qualified for inclusion in the reinsurance agreement.
After CIFG lost its top insurer ratings, it sought to reinsure its policies. It reached a master agreement with Assured on Oct. 31, 2008, outlining what policies would be reinsured as well as part of a future novation process. The reinsurance agreement and a services agreement under which Assured would act as CIFG’s agent were formally signed in January 2009 with a retroactive date to October. It covers what now amounts to $11.1 billion of CIFG-backed bonds .
Xenia was originally part of the pact, but when it became clear the district was nearing default, Assured took the position that the bonds did not qualify as a covered policy. CIFG filed a lawsuit last year in an effort to force Assured to honor the agreement. Assured asked the court instead to declare the policy ineligible for coverage.
In her ruling, Kapnick rejected Assured’s arguments that it should be allowed to retroactively exclude the Xenia policy from the agreement because the district was improperly assigned an investment-grade rating.
The reinsurance agreement renders ineligible for coverage any policies on bonds rated below investment grade by rating agencies or based up on CIFG’s internal ratings on Oct. 31, 2008. At the time, Standard & Poor’s rated the bonds BBB and CIFG rated the bonds at a level equivalent to a BBB-plus from Standard & Poor’s.
CIFG “is entitled to summary judgment in its favor on both its first and second counts and a declaration that Assured is responsible for paying losses relating to and arising out of claims under the Xenia policy,” Kapnick’s order read.
The judge dismissed CIFG’s charge that Assured had acted in bad faith along with Assured’s request that the Xenia bonds be declared ineligible for coverage under the agreement.
Assured did not say Wednesday whether it would appeal the ruling. “We will determine our next steps after reviewing the decision that was issued today on the Xenia Rural Water District, Iowa, water revenue bonds,” read a statement. CIFG did not comment on the court’s action.
Xenia began to draw on its reserves in December 2007, a move that was permitted under the bond indenture and did not trigger a default as long as the district repaid the borrowed funds in monthly installments.
In March 2009, Xenia issued a material-events notice disclosing a further draw the previous December to cover debt service and its failure in February to make its monthly installment payment. CIFG received the notice on March 9, 2009, and forwarded it the next day to Assured.
Standard & Poor’s in August 2009 stripped the bonds of their investment-grade rating, lowering the credit to BB-plus from BBB due to the district’s “deteriorating financial position.” The agency said part of the reason it did not act sooner was because the bond resolution permitted the reserve draws.
In March 2010, CIFG notified Assured that it was unlikely Xenia could fully cover its upcoming June payment from its water revenues and that reserves were exhausted. Assured countered in May 2010 that it had reviewed the Xenia policy and decided it was not a covered policy under the provision allowing for the exclusion of junk-rated bonds.
CIFG paid the shortage of about $70,000 on the June 2010 payment and covered a $1.3 million shortage on the December 2010 payment. Standard & Poor’s lowered Xenia’s rating to D following the June 2010 default.
Assured in court documents said it relied heavily on CIFG during the due-diligence process leading up to the reinsurance agreement, but it never charged that CIFG had purposely failed in its surveillance efforts of the Xenia credit. Assured did ask the judge to allow the parties to review whether the Xenia bonds were “deserving” of the investment-grade level rating they carried when the pact was struck, but that request was dismissed as part of the summary judgment Tuesday.
Assured argued the bonds “should have been” rated below investment grade and thereby ineligible for coverage. Kapnick rejected that argument and applied in her ruling language in the reinsurance agreement that states policies could be excluded based on the ratings “as of the effective date” of the pact. There was no dispute between Assured and CIFG over Xenia district’s published ratings at the time.
As Xenia grapples with insolvency, the ruling should give bondholders cause to cheer as it bolsters the value of their holdings since Assured is in a much stronger position to make good on future debt service payments than CIFG.
In April, Assured announced it would begin the process that eventually should lead to it directly guaranteeing bond insurance policies originally issued by the now-defunct CIFG. The novation of policies would take CIFG out of the equation entirely, replacing the CIFG guarantee with Assured’s. That could increase the credit ratings on the wrapped bonds.
Credit agencies have withdrawn their junk ratings on CIFG, while Assured boasts double-A grades from both Moody’s Investors Service and Standard & Poor’s.
“The novation, if successful, will provide bondholders with AGC’s direct guaranty of their bonds,” Assured said a press release. Assured already provides full reinsurance for the covered policies but CIFG “remains the insurer until the policies are novated, and the bondholder remains subject to credit risk of CIFG,” the release said. Assured and CIFG will first seek consent for novation on bonds insured in the primary market. The offer to novate a particular policy will be open through July 15.
The Iowa auditor recently issued a report warning that Xenia’s financial position worsened in 2010, moving it closer to insolvency and increasing the pressure on the district and its creditors to come to some agreement that likely includes debt forgiveness. The revenue bondholders, however, are not asked to take a haircut on their holdings.
The district ended 2010 with $140.1 million of liabilities, including its $83 million of water revenue bonds. In March it unveiled a five-year restructuring to restore it to fiscal solvency, but the plan hinges on the willingness of some creditors to forgive portions of their debt holdings.
The proposal is far from final and all creditors must approve it. Xenia officials have said most of the creditors are on board, though they have not formally committed to the plan in writing, but there are holdouts.
The district was fully able to cover its most recent debt-service payment due earlier this month on its own.