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Bond Insurer FGIC Ordered To Stop Writing Policies and To Cease Paying Claims; ISDA Announces FGIC 'Failure to Pay' Credit Event

3rd Quarter Financials Lead to Action By NYS Superintendant of Insurance and ISDA

On November 24, 2009, Financial Guaranty Insurance Company ("FGIC"), a New York- domiciled monoline financial guaranty insurer, was ordered by New York's Superintendent of Insurance to cease writing any new policies and to suspend payment of all claims. The Superintendent's order follows FGIC's Quarterly Statement for the third quarter of 2009, in which FGIC reported that as of September 30, 2009, it suffered an impairment of its required minimum surplus to policyholders of $932,234,577.

FGIC presented the Insurance Department with a proposed "Surplus Restoration Plan" intended to remediate its exposure to certain residential mortgage-backed securities ("RMBS") and collateralized debt obligations of asset-backed securities ("ABS CDOs"). Under the plan, FGIC proposes to take the following steps:

Commence a tender offer for the acquisition or exchange of certain RMBS guaranteed by FGIC;
Continue to pursue commutations with the holders of ABS CDOs; and
Commute, terminate or restructure FGIC's exposure with respect to other obligations for which it had established statutory loss reserves.

Under the Superintendent's order, FGIC has until January 5, 2010 to submit a detailed and final proposed Surplus Restoration Plan to the Insurance Department. If the plan is not submitted by that date, the Superintendent will seek an order of rehabilitation or liquidation, in essence commencing an insurance company insolvency proceeding. Any liquidation or rehabilitation would be conducted pursuant to New York insurance law since insurance companies are not eligible to be debtors under the United States bankruptcy laws. The Superintendent would serve as a rehabilitator or liquidator in any such state court proceeding.

FGIC also has been ordered to bring its minimum policyholder surplus into compliance with New York's surplus and capital requirements by March 25, 2010, unless the Superintendent gives it additional time. Until such time as FGIC is in compliance with the New York surplus and capital requirements, it is limited to operating only in the ordinary course of business and to effectuating the Surplus Restoration Plan. Further, the Superintendent retains the right to seek an order of liquidation or rehabilitation against FGIC at any time, so long as it is not in compliance with these capital and surplus requirements.

On December 3, the International Swaps and Derivatives Association, Inc. ("ISDA") announced that a "failure to pay credit event" occurred with respect to FGIC as a reference entity for credit default swaps ("CDS"), triggering the termination and settlement of these over-the- counter derivatives. ISDA's America's Credit Derivatives Determinations Committee also voted to hold an auction to determine the cash settlement price of these CDS transactions, and will be publishing auction terms in due course.

What Does This Mean For You?

FGIC Policyholders, creditors of FGIC, parties to swap agreements with FGIC, and parties to CDS contracts which reference FGIC or securities issued by FGIC each need to review their respective agreements and assess carefully their potential exposure and rights in light of these developments. Although the actions by the Insurance Department are just the beginning of a process that may lead to full-blown insurance company insolvency proceedings, these developments also may have an immediate and tangible effect on clients' insurance coverage, payment of claims and contractual rights under financial guaranty policies and derivatives contracts. Further, for counterparties to derivatives contracts with either FGIC or referencing FGIC securities, termination, closeout and netting rights may have been triggered and must be reviewed as soon as possible to maximize your position and minimize losses. Reed Smith can assist you in this process and help you to preserve and assert your rights now, as well as during and after an insolvency proceeding, should that occur.

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David M. Schlecker
Partner, New York
+1 212 205 6083

Andrea J. Pincus
Partner, New York
+1 212 205 6075