Feb. 20 (Bloomberg) -- Hedge-fund manager William Ackman, who has bet against bond insurers including MBIA Inc. and Ambac Financial Group Inc., proposed restructuring the companies so more capital stays within their insurance subsidiaries.

Ackman, managing partner of Pershing Square Capital Management LP in New York, said the companies' insurance units should be divided into separate municipal and asset-backed businesses. Dividends should flow to the asset-backed unit from the stronger municipal insurance operation, he said in a proposal to regulators, lawmakers and banks yesterday.

State regulators are pressuring bond insurers to make sure the municipal debt they back retains its AAA credit ratings. Credit rating companies are reviewing whether the bond insurers still merit top ratings, given downgrades of securities backed by subprime mortgages that they guarantee.

The proposal ``offers the best prospect for protecting the most policyholders and ensuring a viable ongoing municipal bond insurance market,'' New York law firm Edwards Angell Palmer & Dodge LLP, which performed an analysis for Pershing, said in a memo included with the presentation. Copies were obtained by Bloomberg News and confirmed by Ackman.

Separate Boards

Ackman proposed two separate boards of directors, one for the municipal insurer and the other for the structured finance unit. Each board would include policyholders. The municipal insurer would pay dividends to its structured-finance parent only when the board was satisfied the unit could remain AAA rated. The structured finance insurer would send dividends to the holding company only after its board determined the money wasn't needed to cover claims.

Ackman would benefit from his plan because he has short positions and credit-default swaps that would gain in value if the holding companies were unable to make debt payments.

``This proposal is simply a continuation of Mr. Ackman's campaign to profit from his short positions and credit default swaps in the bond insurance industry,'' Armonk, New York-based MBIA, the biggest bond insurer, said in a prepared statement. ``We believe his proposed structure is also an attempt to find some way to make true his predictions that the holdings companies are or will soon become insolvent.''

Vandana Sharma, a spokeswoman for Ambac of New York, declined comment.

New York State Insurance Commissioner Eric Dinallo said last week that bond insurers could be split into separate companies to protect municipal bondholders.

``Our concern with the Ackman plan is that it would split the company and the structured side could be substantially downgraded which would be bad for the banks,'' said David Neustadt, a spokesman for the New York State Insurance Department. ``Our preference is a plan that keeps an AAA rating on everything.''

Municipal Policyholders

Under the ``good bank, bad bank'' structure, municipal policyholders would be protected against claims related to defaults on subprime mortgage securities.

Pressure on the bond insurers was ratcheted up last week after New York Governor Eliot Spitzer said he expected the companies to come up with plans for maintaining the top ratings on municipal bonds they insure within three to five days.

No clear path has emerged for how the bond insurers will salvage their businesses, according to Kathleen Shanley, an analyst with independent research firm GimmeCredit.

`No King Solomon'

``There are too many competing, and conflicting interests, and no King Solomon to adjudicate on the fairest way to slice up the baby,'' Shanley wrote in a report today.

Ackman isn't the only one to question whether the split would be fair to structured finance policyholders.

Any ``restructuring would include some type of arrangement under which the good bank would send to the bad bank any monies in excess of what is required to maintain the good bank's insurance financial strength rating at AAA,'' wrote Michael Barry, a New York-based analyst at Bank of America Corp., in a Feb. 19 research report.

The bond insurers guaranteed $127 billion of collateralized debt obligations backed by subprime-mortgage securities as of June 30, according to Standard & Poor's. CDOs are created by packaging debt or derivatives into new securities with varying ratings. Most of those guarantees are in the form of derivative contracts. Subprime loans are made to borrowers with poor credit.

Ackman has estimated that MBIA and Ambac could each lose $12 billion on CDOs and other mortgage-related securities, including those backed by home-equity loans. MBIA in the fourth quarter estimated its losses on those guarantees at $913.5 million, while Ambac said it expected to pay claims of $1.1 billion.

Ackman has been critical of the AAA credit ratings on the bond insurers since 2002, when he first wrote a report titled ``Is MBIA Triple-A?''

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt.

To contact the reporter on this story: Christine Richard in New York at crichard5@bloomberg.net

Last Updated: February 20, 2008 17:15 EST