NU Online News Service, July 5, 12:06 p.m. EDT

A decision by the New York State Court of Appeals allowing a group of banks to proceed with its lawsuit against MBIA’s 2009 restructuring of its insurance operations has mixed credit implications for the MBIA family of companies, Moody’s says.

In a decision last week, the court voted 5-2 to allow the banks to pursue their claim that the split of MBIA into two companies left the bank policyholders with an insolvent company that would be unable to pay claims. The court says there was no legal basis to “extinguish the historic rights of policyholders to attack fraudulent transactions.”

Armonk, N.Y.-based bond insurer MBIA was split into two companies in 2009, with one company, National Public Finance Guarantee (NPFG), holding onto the company’s healthy portfolio of municipal bond insurance, and the second company, MBIA Insurance, retaining the structured-finance policies that became toxic with the housing implosion during the great recession.

The banks that secured coverage for their structured-finance agreements contend that the split left MBIA with no capital to back-up the policies. The banks produced a study that claims the insurer underestimated its losses by $10 billion.

Moody’s notes in its Weekly Credit Outlook that the banks’ complaint, originally filed in May 2009, alleges that MBIA had executed a series of fraudulent conveyances that resulted in the illegal transfer of assets and cash flows away from the banks’ insurance claims.

The banks also filed Article 78 litigation against MBIA and the New York State Insurance Department, contending that the department’s approval of the MBIA restructuring was “arbitrary and capricious.”

The New York State Supreme Court denied a motion by MBIA to dismiss the banks’ claims, Moody’s says. An appeals court reversed that decision and approved the motion to dismiss. The Court of Appeals’ latest decision to allow the case to proceed is final, Moody’s notes.

As for the credit implications, Moody’s says MBIA Insurance Corp., which holds the structured-finance policies, would benefit from “any event that increases the likelihood of a reversal of restructuring….”

However, for NPFG and holding company MBIA Inc., the latest decision is credit-negative. Moody’s says that, with respect to NPFG, the decision “increases the potential for deterioration in its capital if a portion of its capital resources are allocated to MBIA Insurance Corp. and could further delay its plan to re-enter the municipal new issuance market.”

The decision is negative for MBIA Inc. because it depends on NPFG’s dividend capacity to meet its future debt services obligations, Moody’s says.