Investors holding securities wrapped by Financial Guaranty Insurance Co. (FGIC) recently formed a policyholder group in an effort to negotiate a restructuring and avoid the insurer’s liquidation.

Once the fourth-most active bond insurer — in 2007 it wrapped $29.62 billion in municipal deals, according to Thomson Reuters — FGIC has not written any new bond insurance policies since January 2008. It suffered near-fatal losses from insuring risky mortgage assets that defaulted during the financial crisis.

Its parent company filed for Chapter 11 bankruptcy protection on Aug. 4. FGIC Corp. had total outstanding debt of $391.5 million. The case is proceeding through the U.S. Bankruptcy Court for the Southern District of New York.

The insurer’s regulator, the New York Insurance Department (NYID), suspended FGIC from paying claims in November 2009 after it failed to meet the minimum policyholder surplus of $66.4 million.

FGIC reported a deficit to policyholders of $1.7 billion at the end of the third quarter. The NYID has the right to rehabilitate or liquidate the insurer at any time, which would have an unknown effect on policyholders.

“The receivership statutes were not ever written with that kind of problem in mind,” said Harold Horwich, head of the insurance practice at Bingham McCutchen, which is serving as legal counsel to the policyholder group. “That’s one of the problems — the uncertainty.”

Horwich said liquidation or rehabilitation could result in freezing claims for 10 years or more. The formation of the group follows earlier attempts by the insurer to tender certain FGIC-guaranteed securities and bring it back into compliance with capital regulations. FGIC’s tender offer didn’t receive enough participation and the proposal expired Oct. 22.

“Absent any last minute resolution, the department’s only option is to pursue a rehabilitation or liquidation in the near future,” Michael Moriarty, the NYID’s deputy superintendent for property and capital markets, said Friday in an e-mail.

The group includes policyholders of FGIC-guaranteed municipal bonds, residential mortgage-backed securities, and asset-backed securities. Rothschild is financial adviser.

FGIC insures $32.7 billion of structured finance debt and $10.7 billion of international finance bonds. Nearly one-third of its insured portfolio consists of RMBS.

FGIC also insures $14.9 billion of U.S. public finance debt, according to its third-quarter financial supplement. The majority of its public finance portfolio — about $166 billion worth — was reinsured by National Public Finance Guarantee Corp. in early 2009.

Bingham McCutchen announced Thursday the group had formed a steering committee of significant policyholders to work with FGIC and devise a restructuring plan. The goal is to find an equitable solution to all policyholders and other creditors, which would be submitted to the NYID no later than Jan. 31, 2011.

“I’m optimistic that we’ll get someplace where everyone is reasonably satisfied,” Horwich said, adding that the NYID has been helpful and supportive.

James Walker of Fir Tree, a member of the steering committee, said FGIC has been receptive to the group’s ideas and he is hopeful a resolution will be agreed upon shortly.

“We believe it is in the interest of all parties – the company, policyholders, and others – to avoid a liquidation scenario, which could result in a significant delay in the payment of claims by FGIC," Walker said.

Kaye Handley of AIG Asset Management, another member of the steering committee, said the policyholder group is trying to expand to receive as much input from policyholders as possible.
The group is limited to direct policyholders, however, which excludes those holding credit default swaps, Horwich said.

FGIC’s insured portfolio includes $10.1 billion of CDS net par outstanding as of Sept. 30.

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