MBIA Debt-Guarantee Split Sparks Hedge Fund Lawsuit (Update1)

By Jody Shenn
Bloomberg News
March 13, 2009

March 11 (Bloomberg) -- MBIA Inc.'s split of its bond- insurance business was challenged by hedge funds alleging the move hurts owners of about $240 billion of debt while benefiting stock investors, executives and some policyholders.

The reorganization, in which MBIA stripped $5.4 billion of assets and its U.S. municipal business from a unit that now mainly insures only structured-finance bonds, "represents the height of insidious greed," the Aurelius Capital Management and Fir Tree Partners funds said in a lawsuit filed today.

MBIA, the largest bond insurer by outstanding guarantees, last month won the right to split its public-finance and structured-finance businesses after record mortgage losses that cost the company its AAA ratings. The suit seeks to reverse the split, which Armonk, New York-based MBIA has said is needed to resume writing new municipal insurance.

The funds allege in the suit that "the federal government is one of the largest victims of this looting," after the U.S. agreed to share losses on some banks' assets and injected capital into more lenders. The suit, filed in the federal court for the Southern District of New York, seeks class-action status.

MBIA Chief Executive Officer Jay Brown and New York State Insurance Superintendent Eric Dinallo, who approved the split, have said that MBIA's structured-finance unit should have enough capital to continue to pay claims to owners of debt including home-loan bonds, aircraft-lease securities and public-finance securities outside of the U.S.

Solvency Question

David Neustadt, a spokesman for the New York insurance department, and Kevin Brown, an MBIA spokesman, declined to immediately comment.

MBIA's restructuring, announced Feb. 18, resulted in Moody's Investors Service cutting its rating on the structured-debt unit to B3, or six levels below investment grade. The downgrade suggests the spilt harmed owners of notes still backed by the unit while allowing shareholders and investors with about $550 billion of MBIA-insured municipal debt to benefit more from the company's public-finance revenue.

"We think it is the right balance between the different constituencies," MBIA CEO Brown said in response to investor and analyst questions on a March 3 earnings conference call.

That MBIA didn't make its U.S. municipal-only unit, created out of a dormant division renamed National Public Finance Corp., into a subsidiary of its structured-debt business suggests the company itself isn't confident that the latter is "solvent," according to the funds' complaint.

Adequate' Banks

The split creates an "adequate bank-adequate bank" structure, not a so-called good bank-bad bank, Dinallo said in a Feb 18 interview with Bloomberg Television.

Robert Green, a Standard & Poor's analyst, wrote in a Feb. 25 report that suits from investors unhappy with the reorganization were a "possibility" and the split may add to reluctance among bond buyers and issuers about doing new business with MBIA.

MBIA rose 7 cents to $3.74 at 4:15 p.m. New York time in New York Stock Exchange composite trading. The shares have declined 69 percent in the past year before today.

Credit-default swaps tied to MBIA's structured-debt unit have jumped 19.25 percentage points to 72.75 percent upfront from the day before the split was announced, according to CMA DataVision. That's in addition to 5 percent a year, meaning it would cost $7.28 million initially and $500,000 a year to protect $10 million of debt insured by the unit for five years.

Ambac Financial Group Inc., the second-largest bond insurer, is seeking to return to the municipal market by creating a new unit, not by splitting its business.


The New York-based company's insurance regulator in Wisconsin "has taken a very strong view, which is perfectly understandable, that they owe a duty to all policyholders," Doug Renfield-Miller, the planned unit's CEO, said on a Feb. 25 conference call. "They cannot discriminate among policyholders, and so that is effectively what this structure achieves."

The case is Aurelius Capital Master Ltd., et al v. MBIA Inc., et al, 09 Civ. 2242, U.S. District Court, Southern District of New York (Manhattan).

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