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WASHINGTON-Officials of financial guarantee insurer Connie Lee Insurance Co. are in exclusive negotiations for a possible sale to a "highly rated insurance company."

Speculation on possible candidates includes others in the financial guarantee business, including Armonk, N.Y.-based MBIA Inc. and newly created financial guarantee reinsurer RAM Reinsurance Co., based in Hamilton, Bermuda. Other companies that have been named as potential acquirers include Swiss Reinsurance Co., CNA Financial Corp. and ACE Ltd. Spokesmen for those companies had no comment or could not be reached.

Connie Lee's exclusive negotiating period with the insurer it is talking to is expected to end in mid-October. But the company may not necessarily be sold, said its chairman, Caspa L. Harris Jr. Connie Lee is "just checking out" a proposal, "but no decision has been made to sell at this point," he said.

Connie Lee, which had about $155 million in shareholders' equity as of June 30, was established in 1986 as a government-sponsored enterprise and began reinsurance operations in 1988.

It originally was restricted to reinsuring higher education debt rated no higher than BBB, though 1992 legislation permitted it to insure A rated debt as long as it had first been rejected by private monoline financial guarantee insurers. The insurer never claimed more than a small portion of the financial guarantee market.

In 1996, after several years of lobbying by Connie Lee, President Clinton signed legislation that privatized Connie Lee and permitted it to expand its scope. The privatization process was completed in February, when Connie Lee repurchased 1.9 million shares of its common stock from the U.S. Department of Education for $18.4 million.

Then in April, Oliver R. Sockwell, Connie Lee's president and chief executive officer, who had been with the insurer since its inception, announced he planned to retire, and the company said it would seek a successor.

In June, after a potential bidder contacted it, Connie Lee put off a search for a successor and brought in investment banker Wasserstein Perella & Co. to explore its strategic options, including a sale. According to one market report, that bidder was Russ Fraser, who now heads American Capital Access, a new financial guarantee insurer (see related story.). Mr. Fraser could not be reached for comment.

"When we got the first inquiry, others felt that they should have an opportunity to look as well," said Mr. Harris. "So we said to a limited group. . .'OK, we'll let you come in and take a look,'*" said Mr. Harris, who noted that a number of companies had responded.

Meanwhile, Standard & Poor's Corp., the only agency that rates the firm, put Connie Lee's AAA rating on Credit Watch. AAA ratings traditionally have been crucial to financial guarantee insurers, because they confer these on the lower-rated issues they insure.

S&P noted in its announcement that the company has historically demonstrated low growth, but in the three months since it said it was examining its strategic options, growth has stalled. "This inability to grow and ultimately generate adequate returns to shareholders raises concern about the company's ability to maintain its AAA claims-paying ability," S&P said in its announcement.

"Their momentum was hurt by the CEO resignation announcement and then was compounded by the uncertainty of whether or not the company would be sold," said Richard P. Smith, a S&P senior vp in New York.

Mr. Harris said he disagreed with S&P's action, noting it was normal for people to stop bringing the insurer deals if they were not sure whether it would be sold. "We don't think we should be (on the Credit Watch)," he said.

Discussing Connie Lee's decision to consider a sale, Brady N. Tournillon, an analyst with Fitch Investors Service in New York, said, "Now that they've privatized and are able to insure deals in other sectors, they're just at a competitive disadvantage to the larger bond insurers," partly because their smaller capital base limits the size of the deals they can insure. Their insured bonds trade at a lower level than do those of the larger bond insurers as well, said Mr. Tournillon.

Anne Ross, vp and manager of research at Roosevelt & Cross in New York, said, "They've not really made any headway in increasing their market share."

Although its staff was expanded, "nothing really took shape on the deal's origination side," she said. In addition, the company was "not having a tremendous amount of luck" in securing Mr. Sockwell's successor.

Louise Costikyan, an analyst with Merrill Lynch & Co. Inc., said: "I think the reason for the sale is that they had a long list of institutional shareholders. . .who were just ready to get out. They were in it for a number of years and were ready to liquidate their investments."

Ms. Costikyan said she thinks one possible buyer for Connie Lee would be a property/casualty insurer.

"The credit skills that are inherent in a bond insurer have real value as the capital markets and the insurance markets converge," she said. "I think the bridge between those two is these credit underwriting skills," which are found in bond insurers. Furthermore, while Connie Lee "doesn't have top-notch underwriters," its AAA rating does have value, said Ms. Costikyan.

S&P's Mr. Smith said there are two likely scenarios: "One set of buyers would be someone who wants to get into the (bond insurance) industry who's not in the industry today."

"Maybe there's some synergies with what they do, i.e., a company that's involved with securitization" and wants to link up with a company that can provide financial guarantees, said Mr. Smith. It could be a firm that may not intend to follow Connie Lee's original game plan but is interested primarily in its AAA rating, he said.

Another scenario would be a company already in the financial guarantee industry that "just views it as an opportunity to get a block of business, and under that scenario, they'd have no interest in an ongoing entity," he said. Connie Lee then would be put in runoff.

"There's a lot of possibilities" as to how a runoff would be structured, said Mr. Smith.

Fitch's Mr. Tournillon said he thinks one possible risk for bond holders is that an institutional buyer that does not plan to continue operating it would buy the company, put it into runoff and distribute its capital in the form of dividends up to the statutory limits, because maintaining an AAA rating no longer would be a consideration. In that case, anybody holding Connie Lee insured bonds would risk having those bonds downgraded, said Mr. Tournillon.