Dinallo sees bond insurer crisis closer to end

By Joseph A. Giannone

NEW YORK (Reuters) - The bailout of bond insurer Security Capital Assurance solved one more piece of the credit crunch puzzle and brought more certainty to a critical part of the financial markets, New York Insurance Superintendent Eric Dinallo told Reuters on Tuesday.

Merrill Lynch & Co MER.N on Monday helped bail out Security Capital SCA.N by canceling $3.5 billion of credit default swaps (CDS) and withdrawing litigation. SCA will be released from swap guarantees it sold to Merrill and will pay $500 million to the bank.

As part of the deal, Bermuda reinsurer XL Capital (XL.N), which spun off SCA in 2006, will pay $1.78 billion and issue 8 million shares to SCA.

While the deal comes at a cost for all parties involved, it helped dispel clouds that had hung over all three companies and the rest of the bond market.

"This is the potential beginning of the resolution," Dinallo said in an interview. "This offers a template for all the other CDS out there. We now have some market comparables, some clearing prices for at least some CDS."

Last year bond insurers, which had expanded into providing guarantees for mortgage securities, were slammed by the subprime market crisis. By January 2008, there were fears that insurers such as MBIA Inc (MBI.N) and Ambac Financial Group Inc (ABK.N) would lose their triple-A ratings, sending the market for municipal bonds and investment bank stocks reeling.

At that point, Dinallo said he stepped in and pushed for Wall Street to provide the capital needed to replenish the system and invited outside investors to form new insurance businesses.

Dinallo said New York state continues to broker deals that will support other insurers. The state Insurance Department recently extended a 30-day deadline for bond insurer Financial Guaranty Insurance Co to resolve its financial issues, he noted.