Following through on a transformation plan announced last year, MBIA last week said it has restructured its insurance subsidiaries to form a new U.S. public finance-only insurer that will operate separately from its structured finance business.

Bond insurance subsidiary MBIA Insurance Corp. ceded its entire $537 billion book of public finance business to subsidiary MBIA Insurance Corp. of Illinois, which MBIA expects to rename National Public Financial Guarantee Corp. and limit to writing only U.S. public finance business. MBIA has paid MBIA Illinois approximately $2.89 billion for reinsuring the public finance business and also capitalized it with an additional $2.09 billion.

MBIA says the split should signal to investors that it will not be using its public finance book to subsidize its structured finance guarantees, and that it has ample capital to meet its expected claims for all parties. MBIA Corp. will retain all structured finance and international exposures.

"The U.S. public finance market is still functioning, albeit under significant stress and difficulty, and we are confident that our guarantee can help improve the liquidity and performance of this market," MBIA chairman and chief executive officer Jay Brown. wrote last week in a letter to shareholders. He first announced initial plans for such a transformation when he rejoined the firm last February.

"Today's move will provide much needed clean capacity for new municipal bond insurance and alleviate pressure in the secondary markets by providing clarity as to the claims-paying resources supporting MBIA-wrapped municipal bonds," Brown wrote shareholders reacted favorably to the news, sending MBIA shares up 29.60% to $4.51.

But rating agencies were less positive on the news. Standard & Poor's downgraded a number of MBIA entities just hours after announcement. It lowered MBIA Insurance Corp. to 'BBB+' from 'AA' and MBIA Illinois - which will become the muni-only insurer - to 'AA-' from 'AA', placing it on developing CreditWatch.

S&P said MBIA Illinois's capital remains slightly below its 'AA' standard. MBIA said it plans to capitalize the business in excess of historical triple-A requirements without diluting existing shareholders.

MBIA also said it continues to explore the possibility of getting help from the Treasury Department about potential assistance. Both MBIA and competitor Ambac Financial Group had asked the federal government for capital injections through its Troubled Asset Relief Program (TARP), but Treasury officials earlier this month told reporters it had no plans to provide direct assistance to the monolines.

Ambac last year proposed recapitalizing its former Connie Lee Insurance Co. into a muni-only subsidiary Everspan Financial Guarantee Corp. and had sought federal capital for the entity.

Ambac has said it plans to go forward with a recapitalization of Everspan - even without a federal capital infusion.

New York insurance superintendent Eric Dinallo said in an interview yesterday that both public and private investors will be much more likely to put capital into the company now that it has split its businesses.

In addition, S&P also had concerns about the ability of MBIA's new muni-only insurer to write new business. Investors may still be wary of MBIA's past performance and may not accept the moves MBIA is making with its by-laws, corporate governance rules, and structure to shield the public finance company from the rest of the business.

"We could raise the rating on MBIA Illinois if it successfully raises capital and credibly ring fences its operations from MBIA," S&P analyst David Veno said in a statement. "However, any rating action based on these factors would most likely remain within the 'AA' category. If MBIA Illinois is not able to raise capital or if legal challenges impair management's restructuring efforts, we could lower the ratings."

Moody's Investors Service later in the day downgraded MBIA Insurance to 'B3' from 'Baa1', but put MBIA Illinois's 'Baa1' insurer financial strength rating on review for upgrade, citing its muni-only focus and strong risk-adjusted capital position.

But the credit agency said the potential for upgrade was "tempered" and the rating was unlikely to move above the A level because of challenges for MBIA Illinois and the financial guaranty industry as a whole. Moody's had said in a November report that a triple-A rating for any stand-alone muni-only insurer was unlikely.

Brown wrote in his letter that the company expects skepticism about the new insurer. In addition to separating the public finance entity, MBIA says it will leverage its experience in the market and work to educate investors.

MBIA said it will move its public finance staff to MBIA Illinois and contract with MBIA or transfer others from the company for other support services.

It remains unclear if the market will accept these efforts. Gary Ransom, an equity analyst at Fox-Pitt Kelton Cochran Caronia Waller who covers MBIA, said he has "very little expectation" for new business this year.

In a research note to investors, Ransom said the restructuring was a positive for investors, but the "next important milestone" will be any capital raises and the eventual ratings the new company earns.

Some participants have said the municipal market is in great need of credit enhancement capacity, as only insurance from Berkshire Hathaway Assurance Corp., Assured Guaranty Corp., and Financial Security Assurance adds much value.

Berkshire has written limited primary market business and Assured has agreed to acquire FSA, although both plan to maintain their licenses. With most financial guarantors downgraded due to the billions in losses they racked up through structured finance exposures, just 18.4% of bonds came to the market wrapped by insurance in 2008, compared to nearly 50% in recent years.

The MBIA announcement was unlikely to immediately affect House Financial Services Committee chairman Barney Frank's calls for the establishment of a federally supported insurance program for the muni market.

Dinallo, who has worked to rehabilitate the bond insurance market, said MBIA's plan will help municipal and structured policy holders as well as its bank counterparties, and that both MBIA Corp. and MBIA Illinois will have sufficient resources to meet claims. MBIA has also said it plans to move the muni-only insurer to be a company domiciled in New York.

Dinallo emphasized its especially important to get another municipal insurer running at a time when the federal government has emphasized increasing spending through the stimulus to help state and local governments meet their infrastructure needs.

"What's exciting about this is you have the opportunity for a major bond insurer to move forward and start to do a large number of municipal wraps that wasn't there before," the insurance superintendent said. "There's been a solid clamor for bond insurance, and I hope this will give a push toward that."

An excerpt from a report by Jack Herman of The Bond Buyer/with additional reporting by Andrew Ackerman and Dan Seymour

(c) 2009 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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