Executive Life Insurance Co.'s $1.93 billion of municipal's guaranteed investment contracts are insurance policies with the same claim on the bankrupt insurer's assets as pension GICs and annuitants, Judge Kurt Lewin decided Friday.
The decision greatly relieved the municipal and life insurance markets by legitimizing an investment product routinely used throughout the 1980s. John Garamendi, California's insurance commissioner, argued unsuccessfully that the contracts should be considered outright loans, which would have doomed the GIC claimants to 100% losses.
Carl Rubenstein, chief counsel for the insurance commission in this case, last week said an appeal is likely.
The Los Angeles Superior Court Justice, who is overseeing the insurance commission's rehabilitation of Executive Life, sided with lawyers for bondholders and trustees.
"Given the nation's economic environment and the instabilities of the financial markets, it's a major accomplishment" to support the GIC markets, said Dominick Carollo, vice president at Svenska Handelsbanken, a bank investment contract issuer. "I applaud Judge Lewin."
The uncertainty over Executive Life's GICs damaged the life insurance market immediately after Mr. Garamendi's intentions became known last April. Issuers, underwriters, and GIC brokers invested proceeds in bank investment contracts and other reinvestment vehicles rather than run the risk of losing during a conservatorship, no matter how remote.
"Issuers are less inclined to do investment agreements with insurance companies," said one GIC broker, who asked not to be identified, citing existing relationships with life insurers.
Now that municipal GICs are what the market had assumed they were all along, however, it may be a while before the sector's competitiveness returns to its former strength. The conservatorship of Mutual Benefit Life Insurance Co. and downgrades for other life insurers involved in the municipal market have instilled an uneasiness with parking bond proceeds with the insurance industry, market sources have said.
Mr. Garamendi's tack in the trial was to attack the nine taxable bond issues sold in 1986 as illegitimate transactions designed to generate fees for unscrupulous underwriters, especially Drexel Burnhan Lambert Inc. -- senior manager on eight of the deals. Further, he said professional traders seeking capital gains now hold the bonds.
As a result, a finding in favor of the municipal GICs would mean less money for California residents -- many of whom had significant life savings threatened by Executive Life's failure -- and more money for already wealthy speculators, Mr. Garamendi's chief counsel, Carl Rubenstein argued.
Estimates for how many of the bonds are now in professional hands vary from 35% to about 70%, but there is no doubt market speculation has been heavy. In the past two weeks, prices on the taxable bonds rose from 26 cents on the dollar to a high of 35 cents, according Stephen C. Leslie, senior vice president of trading at M.R. Beal & Co.
"It was all in anticipation of a favorable decision," Mr. Leslie said. "A little bit of the steam came off" late Wednesday when Judge Lewin postponed the decision, "and some guys decided to sell, but everybody's been excited."
Judge Lewin determined that GICs sold to pensions were equivalent to the GICs sold to municipal issuers. Indeed, reinvestment professionals have said the documents contain precisely the same language and in some cases are identical.
The decision directly affects efforts to sell Executive Life. Now that municipal GIC interests are a legitimate claimant class, the winner of the contest to buy the life insurer must give bondholders the same deal as pension GICs.
The insurance commissioner has been charged with recommending a buyer for Executive Life, but Judge Lewin ultimately is scheduled to decide today which party will get to manage the firm. The prize is significant: Executive Life has about $10 billion in assets, 170,000 outstanding policies, and about 75,000 annuity customers.
Early Thursday, Mr. Garamendi backed a controversial $3.55 billion cash bid for Executive Life by a French investor group healed by Altus Finance, a subsidiary of Credit Lyonnais. Market participants, particularly corporate bond professionals, said the offer's $3.25 billion sale price for Executive Life's junk bond portfolio was grossly undervalued.
But even more grating to many participants is that Drexel's former chief of mergers and acquisitions -- Leon Black -- would eventually obtain the high-yield portfolio through the transaction. Mr. Black and other ex-Drexel officers comprise Lion Capital, adviser to Altus Finance. The Drexel connection to Credit Lyonnais was first reported by The Wall Street Journal.
Counsel for bond trustees said Mr. Garamendi's support for the Altus bid -- and thus Mr. Black's role as manager of the Executive Life portfolio -- is surprising given that attacking Drexel was the main strategy in Mr. Garamendi's case against against the municipal GICs.
The commissioner contends that two aspects of the Altus Finance/MAAF offer set it apart. First, the transaction would involve selling the junk bond portfolio, removing the risky securities that contributed heavily to the life insurer's failure. All cometping bids left the junk bonds within the rehabilitated firm. Second, Class 5 policyholders would get 89 cents on the dollar from Altus Finance, more than from two other strong contenders, Mr. Garamendi said Thursday.
Mr. Garamendi flirted briefly with a competing bid from an industry group, the National Organization of Life and Health Insurance Guaranty Assocuations, but rejected the bid last week as insufficient. One municipal source characterized the NOLHGA bid as "a stalking horse," or a strategy to lend credence to an essentially anti-competitive auction.
"They have done a good job of convincing the news media that this is a legitimate bidding process," the source said. "But this is by no mean over." The official, who is allied with a competing bid, asked not be identified due to possible legal actions contesting the eventual winner.
The other finalist in Mr. Garamendi's Executive Life contest was San Francisco-based Hellman & Friedman.
All told, there are 16 municipal issues with Executive Life GICs -- nine taxable deals sold in 1986, six tax-exempt issues sold in 1989, and one tax-exempt deal sold in 1985.
The 1986 bonds include: a $400 million Memphis Health, Education & Housing Facility Board offering; a $300 million multifamily housing issue sold by the Adams County, Colo., Industrial Development Authority; a $300 million Southeast Texas Housing Finance Corp. issue; a $200 million El Paso Housing Finance Corp. issue; two $150 million Louisiana Agricultural Finance Authority offerings; a $150 million Louisiana Housing Finance Authority issue; and two Nebraska Investment Finance Authority deals, each a $100 million.
The six 1989 deals are two St. Paul, Minn., Housing and Redevelopment Authority multifamily housing revenue bonds insured by the Federal Housing Administration, together totaling $11.28 million; a 1989 $7.63 million Tucson, Ariz., multi-family housing, variable-rate issue, also insured by the FHA; and three small California issues sold by Simi Valley, Whittier, and Temecula Valley Unified School district, totaling $47.41 million.
The 1985 deal, originally insured by Bond Investors Guaranty, is an $11.9 million borrowing by Eureka, Mo. Municipal Bond Investors Assurance Corp. now guarantees the issue.