The New York Superintendent of Financial Services has filed a rehabilitation plan for bond insurer Financial Guaranty Insurance Co. that will initially pay 15% on policy claims.

According to a FGIC document, on March 31 the company insured $12.3 billion in domestic public finance. This is about 31% of its insured portfolio.

The superintendent proposed the rehabilitation plan to the New York State Supreme Court in New York County. Justice Doris Ling-Cohan is handling FGIC’s rehabilitation and will rule on the plan.

Before the most recent recession, FGIC was a major insurer of municipal bonds. However, it stopped writing new insurance in January 2008 after experiencing unexpected large losses on residential mortgage-backed securities it insured.

In the third quarter of 2009 FGIC reported an impairment on its required minimum surplus to policyholders of $932 million. In November 2009 the New York State Department of Financial Services ordered FGIC to suspend paying claims.

“FGIC was subsequently unable to eliminate the impairment of its policyholders’ surplus through an out-of-court surplus restoration plan,” the company reported. “Therefore, the superintendent has determined that it is necessary to place FGIC into rehabilitation.”

The rehabilitation is not a liquidation.

Since 2009 bond insurer National Public Finance Guarantee has reinsured the bulk of FGIC’s insured public finance. Effectively this meant that National paid claims for defaults on the bonds.

However, on Sept. 14 FGIC reached a novation agreement with National for the reinsured bonds. This meant National plans to take over full legal responsibility for insuring the bonds. FGIC is no longer involved with them. The novation is conditional on the judge’s approval of the rehabilitation plan.

“As of June 30th, 2012 (the most recent date available) the aggregate par outstanding of the policies being novated was approximately $118 billion,” National spokesman Kevin Brown wrote in an e-mail. According to a FGIC document, as of March 31 FGIC insured $12.3 billion in United States public finance. That is about 31% of its insured portfolio.

The novation will have little impact on policyholders, according to Brown.

The novation may ultimately benefit some lower-rated issuers, said National chief communications officer Willard Hill. Because of some technical conditions associated with the reinsurance arrangement, Moody’s Investors Services, unlike Standard & Poor’s, had not assigned National’s ratings on the bonds in cases where National had a higher rating. Moody’s rates National Baa2 with a negative outlook.

Once the rehabilitation plan becomes permanent, National will go to Moody’s to ask it to revisit the ratings. The insurer’s rating may be higher than some of the issues that it is insuring and Moody’s may place the higher rating on the bonds, Hill said.

Since National has reinsured the bonds since 2009, the novation will not affect National financially, Hill said.

The rehabilitation plan explains how claims and equity interests with FGIC will be paid.

Secured claims, “shall be paid in full solely from the collateral securing such claims,” the plan states.

Administrative expense claims shall be paid in full.

Policy claims shall be initially paid 15% of the claim and an additional amount if there is money available.

Permitted non-policy claims shall be paid a to-be-determined portion of the claim if there is money left over after the payment of secured claims, administrative expense claims and policy claims.

Late-filed claims will be paid a to-be-determined portion of the claim if there is money left over after the payment of secured claims, administrative expense claims, policy claims and permitted non-policy claim.

Equity interests remain in effect. However, there is to be no distributions to their owners until all the above claims and expected claims are paid.

According to a knowledgeable source, most of the claims on municipal bonds will be made to the “policy claims” category.

Reinsurers shall pay FGIC for the reinsured portion of policy claims.

At least some of FGIC’s credit-default swap agreements are to be commuted, terminated, settled or released, according a plan passage. The terms are set in a plan supplement that The Bond Buyer was not able to obtain.

Among FGIC’s top six U.S. public finance exposures are Jefferson County, Ala., sewer revenue bonds with $1.16 billion in par outstanding, rated Caa3 by Moody’s; California’sGolden State Tobacco Securitization Corp. lease bonds with $1.05 billion in par outstanding, rating withdrawn by Moody’s (last rating was Baa2); and Detroit, bonds with $575 million in net par outstanding, whose best tax-supported bond is rated B3 by Moody’s. The three represent 2.9%, 2.6% and 1.4%, respectively, of total net par outstanding at FGIC.

FGIC did not respond to multiple requests to answer questions or comment for this story.

“The [New York State Department of Financial Services] superintendent, the New York State Department of Financial Services and the company deserve full credit for working together to submit a plan that provides fair and equitable treatment of FGIC’s policyholders,” said James Walker 3d, managing partner of Fir Tree Partners, an investment firm and a major policyholder in FGIC since 2008.

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