Bond insurer MBIA Inc., in a restructuring move that has been in the works for a year, said it is creating a separate entity to handle municipal bond business.

The action splitting off that portion of the Armonk, N.Y.-based firm's business into a separate unit was given final approval by the New York Insurance Department yesterday.

In making its announcement, MBIA said it expects the transaction to provide “critical liquidity” to the municipal bond insurance market, which has had difficulty functioning after financial strength ratings for such firms dropped, making them unattractive as backers of municipal debt.

Negative rating actions followed bond insurer losses related to subprime mortgages and credit derivatives.

New York Insurance Superintendent Eric Dinallo said that with MBIA's new unit, the company could “go to markets and try to attract capital to bring it to a 'AAA' [ratings].”

Ratings firms reacted by downgrading the parent firm, but one said the new unit could be in line for an upgrade, but only to single A.

He explained that this should be possible now because the investment will be limited to the company's solid municipal business. MBIA, without restructuring, was rated “AA.”

Mr. Dinallo said the rest of the MBIA structured-finance business should qualify for a “BBB” rating–enough to support its operation in a runoff. “This is an opportunity for the industry to help with the government fiscal stimulus package,” he added.

MBIA Inc. said the restructuring involved transferring the stock of MBIA Insurance Corp. of Illinois to a new subsidiary holding company, which is expected to facilitate transparency and help future capital-raising efforts.

MBIA Insurance Corp. of Illinois, the parent firm said, is expected to be renamed National Public Finance Guarantee Corp. (National).

“With this company, we have a new, well-capitalized financial guarantee insurer dedicated exclusively to the U.S. public finance market,” MBIA Chief Executive Officer Jay Brown said in a statement.

Mr. Brown expects that, as new insured municipal bonds are issued, public finance markets “will begin to thaw, freeing up much needed capital for future projects.”

MBIA Corp. said it plans to resume business in the international public finance and global structured-finance markets when its ratings and market conditions improve.

The company explained that National, as MBIA Illinois, was acquired in 1989 and was formerly a direct subsidiary of MBIA Corp. It said that MBIA Illinois intends to apply for approval to redomesticate from Illinois to New York, as well as to change its name.

As part of the restructuring, it was explained, MBIA Corp. has ceded to National all of MBIA Corp.'s U.S. public finance business, including assigning the municipal bond business of Financial Guaranty Insurance Company (FGIC) that was reinsured by MBIA Corp. in August 2008. MBIA reinsured $184 billion of FGIC municipal bonds.

The portfolio transferred to National by reinsurance or through the assignment of the FGIC portfolio consists entirely of U.S. public finance business valued at approximately $537 billion as of Sept. 30, 2008.

The reinsurance and assignment, which became effective as of last month, enable covered policyholders to make claims for payment directly against National in accordance with the terms of the cut-through provisions of the applicable agreements.

To provide additional protection for its municipal bond policyholders, the company said MBIA Illinois has also issued second-to-pay policies for the benefit of the policyholders covered by the reinsurance and assignment.

The second-to-pay policies, which are a direct obligation of MBIA Illinois, will be held by The Bank of New York Mellon as insurance trustee.

As a result of the restructuring, MBIA Corp. said National will be one of the only substantial financial guarantee insurers in the United States dedicated solely to the U.S. public finance business.

In connection with the reinsurance and assignment transactions, MBIA Corp. said it paid National approximately $2.89 billion as a premium to reinsure the policies covered by the reinsurance and assignment agreements.

In addition to the $2.89 billion, National has been further capitalized with $2.09 billion from funds distributed by MBIA Corp. to MBIA Inc. as a dividend and return of capital, which MBIA Inc. in turn contributed through an intermediate holding company to National.

MBIA said regardless of how rating agencies judge National, in the short term National is expected to be capitalized to achieve high, stable ratings in order to provide market access and lower-cost funds to public issuers over the long term.

In addition to a transfer of public finance and other staff to National from MBIA Corp., National has entered into services agreements with MBIA Corp. to provide to each other certain administrative and other support services.

MBIA said National's entire portfolio will be posted on www.MBIA.com until its new Web site is launched, and it will be updated monthly to provide maximum transparency and investor analysis at a detailed level.

Standard & Poor's reacted by dropping the credit, financial strength and financial enhancement ratings on MBIA Insurance Corp. to “BBB-plus” with a negative outlook from “AA.” It said it is concerned that adverse loss development on the structured finance book that is being retained could continue.

S&P said operational functions at MBIA's new split-off company will benefit from the stability and continuity of a staff consisting largely of individuals from MBIA who were responsible for the business, underwriting and risk management of its solidly investment-grade public finance book of business.

However, it said “competitive position may suffer from legacy MBIA performance. In addition, there is uncertainty regarding investors' acceptance of the restructuring and ring-fencing plan.”

Moody's Investors Service said MBIA insurance financial strength ratings were downgraded to B3 from Baa1 with a developing outlook. It said MBIA Illinois is on review for possible upgrade noting the possibility of improved business prospects in light of the company's municipal-only focus and strong risk-adjusted capital adequacy.

It noted that MBIA Illinois has approximately $537 billion in municipal net par outstanding and $5.7 billion in hard capital, while MBIA Corp has $240 billion in net par exposure and approximately $9.8 billion in hard capital.

Moody's cautioned that the whole municipal bond sector is challenged and opportunities may be narrower now given changing perceptions about municipal risk among buyers, lower confidence in the financial guaranty industry broadly and a trend toward alternative forms of execution, including the issuance of uninsured paper.

This article was updated 4:30 p.m.

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MBIA Splits Off Municipal Bond Unit

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