On May 9, the New York Insurance Department (the “Department”) issued Circular Letter No. 12 (2008), entitled “Cancellation of Municipal Bond Insurance Policies,” (the “Circular Letter”) in which the Department states that U.S. municipal bond issuers (the “Issuers”) may cancel bond insurance policies under certain conditions.   Issuers have been concerned in recent months about the marketability of their bonds, given recent downgrades and threatened downgrades of financial guaranty insurers’ ratings.   A substantial percentage of municipal bonds issued in the United States are “wrapped” with a bond insurance policy, which Issuers use to boost the investment rating of the bond.  Typically, the bond is rated at the same level as the insurer issuing the financial guaranty policy.   If the insurer’s rating is downgraded, the insured bonds also face lower ratings.  Since many institutional and other investors are not permitted to own securities below a certain rating, Issuers  fear that a downgrade may lead to a mandatory, large scale sell-off of their bonds.

To avoid this situation, several Issuers have sought to cancel bond insurance policies issued by financial guaranty insurers who have been downgraded or threatened with downgrade.  The Department was asked to clarify its position on the issue as several of the insurers “refused . . . [or were] reluctant to cancel or terminate policies . . . either on the belief that cancellation or termination might violate the New York Insurance Law or simply because the insurance policies state that they are noncancelable.”  The Circular Letter states that the Department will not object to any cancellations if the insurance policy does not include a “non-cancellation” provision.  If the policy does include such a provision, the Issuer may cancel the policy only after receiving the consent of the insurer and bondholders.  The Circular Letter goes on to state that the Department “suggests that the insurer work with the issuer and bondholders to ensure that cancellation or termination is not completed precipitously” and that the insurers should “apply a single set of non-discriminatory criteria in determining whether to consent to cancellation or termination of policies.”  A copy of the Circular Letter can be found here.

Click here for our previous coverage of the issues facing financial guaranty insurers.