We’ve been saying that the legal basis for splitting up the bond guarantors and preferring one group of policyholders (municipalities) over everyone else seems pretty dubious and therefore is likely to trigger litigation.
Analysts at Bank of America agree. From Bloomberg:
Regulators’ plans to break up bond insurers into “good” businesses covering municipal debt and “bad” businesses liable to subprime-related losses may trigger “years of litigation,” Bank of America Corp. analysts said.
New York Insurance Department Superintendent Eric Dinallo and New York Governor Eliot Spitzer said last week that insurers may need to be divided if they can’t raise enough capital to compensate for losses on subprime-mortgage guarantees. FGIC Corp., the fourth-largest of the so-called monoline insurers, asked to be split on Feb. 15 after Moody’s Investors Service cut the Stamford, Connecticut-based company’s top Aaa ranking.
“Despite the regulatory interest in separating the exposures, the essential fact remains that all policy holders, whether municipal or structured finance, entered into contracts backed by the entire entity,” analysts led by Jeffrey Rosenberg in New York wrote in a note to investors dated Feb. 15. A breakup is “likely to lead to significant legal challenges holding up the resolution of the monoline issues for years.”…..
“The fact that one group of policy holders’ exposures has imperiled the policies of the other does not mean they should forfeit the value of their claims altogether,” the Bank of America analysts said.
Investors in credit-default swaps based on the bond insurers may also seek damages to compensate for losses, according to the research note.
Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.
The cost of credit-default swaps on Armonk, New York-based MBIA Inc., the world’s largest bond insurer, has soared to $1.7 million upfront and $500,000 a year to protect $10 million of bonds from default for five years, according to CMA Datavision. Ambac credit-default swaps were at the same level as MBIA at the close of trading in New York on Feb. 15. The contracts, which cost $25,000 a year ago, trade upfront when investors see a risk of imminent default.
Any breakup of the companies may cause “significant widening” in the credit-default swaps as the structured finance company is likely to be “deeply distressed,” the Bank of America report said.