According to the investor relations section of the website of FGIC, the bond insurer part-owned by PMI Group and Blackstone:
FGIC provides irrevocable and unconditional guaranty of timely payment of principal and interest on the securities it insures.
As of Tuesday night, that claim no longer rang true.
Late on Tuesday, the long-suffering rival of MBIA and Ambac, disclosed that it had been ordered by New York’s insurance regulator to suspend all claims payments because of its violation of the state’s minimum capital requirements.
According to FGIC’s statement on the matter (emphasis ours):
On November 20, 2009, FGIC filed with the NYID its Quarterly Statement for the period ending September 30, 2009, in which FGIC reported a surplus to policyholders deficit at September 30, 2009 of $865,834,577 and an impairment of its required minimum surplus to policyholders of $932,234,577. The Superintendent of Insurance (the “Superintendent”) has directed FGIC to submit a plan to eliminate such impairment of FGIC’s surplus to policyholders.
The regulator has also banned FGIC from writing any new policies, though this will probably not have a major effect on a company which has had its ratings withdrawn by Moody’s, Standard & Poor’s and Fitch (though not before being quite comprehensively downgraded by each). FGIC has not insured a deal since January 2008.
The regulatory intervention is likely to result in a credit event for credit default swaps written against the bond insurer, although final determination thereof rests with the ISDA committee that decides such things. If that committee determines that a credit event has occurred, however, there could be a spot of bother in the credit markets.
Moreover, according to a Fitch report from 2008:
In the event that some form of regulatory intervention were to occur, FGIC’s exposure to credit derivatives (CDS) would be subject to immediate termination with its outstanding counterparties. In this scenario, FGIC would be required to settle the CDS contracts at their current market value; a level that Fitch believes is considerably greater than the company’s existing claims-paying resources.
For “exposure to credit derivatives” in the Fitch statement, read “contracts with a host of US and European banks”. There is, therefore, a very real risk that any banks that have not comprehensively written down their exposure to FGIC may be obliged to take some unpleasant hits.
How unpleasant? Here’s CreditSights, emphasis FT Alphaville’s:
There will be only minimal recoveries in the case of a CIFG or FGIC failure. With a case specific to the monolines, all counterparties should consider that their liquidation does not adhere to federal bankruptcy code and creditors cannot take control of assets through “cram down” procedures. Recoveries will be pennies on the dollar and will not be realized for at least a decade. That’s right, 10 years. That is what the NY regulators have told us on numerous occasions. If a seizure is required, they plan to shut the books for the next decade before making any distributions so as to avoid a first-come, first-served scenario.
…
Almost all CDS written by the guarantors include solvency provisions. This is the so-called ‘nuclear’ event. If the regulators actually take control of a monoline due to the breach of minimum surplus levels, all of the credit protection that the particular company wrote in the form of CDS could be terminated at current market valuations, putting buyers of CDS protection with monolines as a counterparty in the queue with other claimants in a runoff portfolio. Under this scenario, obligations would increase exponentially and claims-paying resources would become woefully insufficient to meet these obligations.
But RBS analyst Tom Jenkins had a less apocalyptic view on Wednesday, emphasis FT Alphaville’s:
FGIC announced last night that it is to cease all claims paying with immediate effect and this will trigger CDS, as we saw with Syncora. In the interim FGIC is to undergo a restructuring – plan to be delivered to the NY Insurance regulator by 5th Jan 2010 with a return to compliance by Mar 25th, and if it doesn’t then it will liquidate. In the interim, as noted, with SCA a cessation of claims payment triggered CDS last May and that settled at 15c (don’t think there was a sub contract). Thinking to the impact on banks, well we sadly don’t know which banks have exposures to which monoline but all in I would expect FGIC exposures to be relatively small/manageable. The more interesting dynamic is that SCA used the plan which FGIC is adopting as a way to undermine the banks, and buyback RMBS at a huge discount (kind of a one-way commutation) and bring themselves back to life (well, sort of).
The only prior CDS event on a bond insurer involved Syncora, formerly known as XL Capital Assurance, which was itself an operating subsidiary of Security Capital Assurance (SCA). The Syncora event was triggered by a similar order from New York’s insurance regulator to cease payments and restore its capital surplus. In Syncora’s case, CDS protection sellers ended up having to cough up about $8.5m for every $10m they insured.
According to DTCC data, at the time of the credit event the net notional CDS outstanding on Syncora was about $1bn, so it is likely these payouts amounted to about $850m.
FGIC’s financial woes have been well trailed – in April, the company’s auditor warned there was “substantial doubt” about the insurer’s ability to continue as a going concern.
The insurer also has significant exposure — about $1.2bn — to Jefferson County in Alabama. Jefferson County was burnt by an interest rate swap deal with JP Morgan, and has been teetering on the edge of what would be the biggest municipal bankruptcy since California’s Orange County in 1994.Of course, some of Jefferson County’s financial woes were actually attributable to its decision to have its sewer revenue warrants insured by FGIC. When doubts emerged about the bond insurer’s creditworthiness, the county had to endure skyrocketing interest payments on its FGIC-backed auction rate securities. Whew.Still, FGIC is making a good show of having a plan:FGIC is currently formulating a comprehensive restructuring plan contemplating FGIC’s commencement of a tender offer for the acquisition or exchange of certain residential mortgage backed securities (“RMBS”) guaranteed by FGIC in the primary market; FGIC’s continued pursuit of commutations with the holders of FGIC-insured collateralized debt obligations of asset-backed securities (“ABS CDOs”); and the commutation, termination or restructuring of FGIC’s exposure in respect of certain other obligations for which it has established statutory loss reserves; all with a view to remediate its RMBS, ABS CDO and other exposures, remove its capital impairment and return it to compliance with the applicable minimum surplus to policyholders requirement (the “Surplus Restoration Plan”). What that means, in non-monoline speak, is that the insurer is hoping to get counterparties to contracts written on CDOs and other structured products to agree to cancel that protection. It is also seeking to buy back some of the RBMS it has insured from investors.|
FGIC must submit a “detailed and final plan” showing how it would improve its capital position to the New York insurance regulator by January 5 2010; failing that, the bond insurer may be forcibly rehabilitated or liquidated, with the latter the more likely outcome.
Elsewhere in the troubled world of bond insurers, Ambac announced its chief financial officer would resign from the post “to pursue other interests.” We hope those interests are in an industry with something resembling a future.
Related links:
Bond insurer death watch, CIFG edition – FT Alphaville
Ambac stuns investors with good news – FT Alphaville
S&P junks MBIA – FT Alphaville
Bond insurers vs investment banks, redux – FT Alphaville