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Q

Could you discuss the latest regarding the insurer, Financial Guaranty Insurance Company (FGIC)? They appear to be in run off now, and according to latest reports, may be “taken over” by the state of New York given their inadequate capital reserves. Can New York state regulators sequester the capital reserves and unrealized premiums of FGIC’s muni book, thus protecting the insurance coverage on their municipals from further losses from the non-muni book?

A

James A. Klotz responds:

FGIC was downgraded to “BBB” with a Negative Outlook by Fitch Ratings on March 26, 2008. The rating change reflected Fitch’s belief that FGIC’s $5 billion of claims paying resources meets the rating agency’s guidelines at that level, but no longer is sufficient for a higher rating. Fitch indicated that according to its internal loss models, FGIC is short by $5.1 billion to $5.3 billion to be a “AAA” insurer, as they once were.

On the positive side, Fitch noted that FGIC has ample liquidity, and most Collateralized Debt Obligation-related claims the insurer may need to ultimately pay will likely be spread over a long time horizon. While not the best of circumstances, a “BBB” rating does indicate adequate capacity to meet financial obligations. Further, FGIC tended to write insurance business in municipal sectors that are among the safest, i.e., water and sewer bonds and general obligations.

FGIC intends to remain in business with a focus on the less risky business sectors, such as global municipal finance. FGIC has announced a moratorium on writing new business to allow time to rebuild capital, and establish a new licensed insurance entity through which future municipal business would be transacted.

The amortization of existing insured bonds will allow capital to accumulate as bonds mature. Meanwhile, FGIC is seeking, through the courts and other means, to reduce its exposure to CDOs. Fitch believes that FGIC’s rating will not stabilize until capital is rebuilt and the insurer’s exposure to CDOs is capped.

Finally, we do not believe that FGIC’s municipal book can be isolated from its CDO woes. That is the reason the downgrades of FGIC have taken place. The rating agencies assume that current resources must be available for both municipal and mortgage related claims.

If FGIC is successful in establishing a new organizational vehicle to write municipal business, it would likely be able to segregate resources for that purpose.