Storm clouds on the credit crunch horizon

Two major bond insurers are reportedly weighing plans to separate their municipal bond businesses from riskier guarantees of securities tied to mortgage loans -- a move that could increase losses at banks with subprime exposure and prolong the credit crunch.

Talk of reorganizing FGIC Corp. and Ambac Financial Group Inc may also be part of a strategy the companies and regulators are employing to persuade banks to provide more capital so they can keep the ratings they need to continue insuring municipal bonds.

New York Gov. Eliot Spitzer last week told Senate lawmakers last week that if bond insurers can't raise more capital, state regulators intend to break the companies up in order to protect their municipal bond insurance businesses from riskier guarantees of collateralized debt obligations (CDOs).

That would allow the new companies to continue insuring municipal bonds, but might force banks and other financial institutions that had been counting on bond insurers to cover some of their losses in CDOs to declare larger write-downs.

FGIC Corp. on Friday informed the New York State Insurance Department that it planned to create a new company to insure municipal bonds, leaving an existing company under its umbrella to cover claims on riskier debt securities, the Wall Street Journal reported. In a separate article today, the Journal reported that Ambac is further along in discussions to undertake such a reorganization.

Meanwhile, the nation's largest bond insurer, MBIA Inc., has raised more than $2.5 billion in capital to preserve its triple-A credit rating in the face of mounting losses, the Journal reported.

Moody's Investors Service on Feb. 14 downgraded the insurance financial strength ratings of FGIC's operating subsidiaries from "Aaa" to "A3," and FGIC Corp.'s senior debt rating to from "Aa2" to "Ba." In announcing the downgrades, Moody's said "MBIA and Ambac are better positioned from a capitalization and business franchise perspective" but that both company's ratings are under review. 

Standard & Poor's Ratings Services said last month that worsening performance of subprime mortgages could lead to a 20 percent increase in projected losses for mortgage and bond insurers, and warned of possible downgrades of several company's ratings (see Inman News story).

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