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05 Dec 2007
Moody's Evaluation Of Financial Guarantors' Mortgage Risk -- An Update
New York, December 05, 2007 -- Last month, Moody's outlined the approach we are taking to
assess the impact of deteriorating conditions in the US mortgage market
on ratings of monoline financial guaranty insurers. Since that
time, we have received numerous inquiries from investors and other
market participants regarding our specific analytic methods, our
process and timing for concluding this assessment, and the likelihood
of ratings reviews or downgrades. This comment is intended to update
the market about Moody's analytic work as well as to offer additional
detail about methods and process.
To assess the impact of continuing mortgage market deterioration on financial
guaranty capital adequacy, Moody's is employing a two-pronged
analytical approach. Under the first approach (the "base
case"), we are re-estimating financial guarantor capital
adequacy ratios using Moody's traditional financial guaranty portfolio
model, a transaction-by-transaction stochastic stress
model, by updating the risk estimates associated with RMBS and ABS
CDO exposures in light of Moody's recent rating actions in these
sectors, and, in some cases (e.g., where
ratings are under review), forming estimates of potential future
Under the second approach (the "stress case"), we are
refining the stress case simulation model described in Moody's September
25, 2007 report on the financial guarantors' exposure to mortgage
risk within ABS CDOs. Rather than applying the broad subprime collateral
performance assumptions used in that earlier stress model, the new
model draws upon Moody's pool level performance assumptions for
individual RMBS collateral types, thereby incorporating differences
in collateral performance by vintage, asset type and lender.
In addition, the new model also considers the impact of projected
timing of losses. We intend to apply this updated stress model
not just to ABS CDOs, but to other mortgage related exposures as
well. These additional refinements are intended to provide greater
confidence in the results and enable Moody's to better assess a
guarantor's ability to withstand a range of stresses related to
the ultimate performance of mortgage risk.
Other key considerations in our ratings assessment will include the impact
of recent developments on the financial guarantors' future business
models and franchise value. The stability of a guarantor's
business model is largely a function of the market's receptivity
to its product and strategy. There are a number of factors that
influence this analysis including general market conditions and spreads,
the robustness of specific markets where financial guaranty insurance
is considered to add value, regulatory guidelines, competitive
dynamics, access to capital, and the willingness of market
participants to purchase and hold a guarantor's wrapped paper in
light of investment guidelines and evolving perceptions of credit risk.
The views of various investors, financial intermediaries and other
market participants will be considered in our analysis.
PROCESS AND TIMING
The decision to undertake additional stress case analysis reflects the
uncertainty surrounding future mortgage market performance and the potential
effect of different outcomes on guarantors' RMBS and ABS CDO exposures.
Our approach is to assess the impact of different scenarios on a firm's
capital adequacy by comparing model results against Moody's established
capital benchmarks. As part of this process, we are reviewing
specific transactions that result in significant modeled loss contributions
in order to confirm our understanding of each one's structure and
to identify the specific risk characteristics that lead to such modeled
Upon the completion of this analysis -- within two weeks --
we will take any rating actions appropriate, giving consideration
to the firm's near- and medium-term capital plans.
We will also form a judgment about the likely future demand for the guarantor's
core credit enhancement product in light of investor sentiment and general
market conditions, as well as the impact that these factors may
have on the firm's profitability and financial flexibility.
LIKELIHOOD OF RATING ACTIONS
Key Factors Considered:
There are three factors that will largely determine whether Moody's
takes rating actions on those financial guaranty insurers most exposed
to deterioration in the mortgage markets: 1) Current capital adequacy
-- whether the guarantor meets Moody's capital adequacy benchmarks
for its rating; 2) Prospective capital adequacy -- whether the
guarantor will meet Moody's capital adequacy benchmarks in the near
and medium term, and 3) Strength of franchise and business model
-- whether the guarantor will be able to access, going forward,
attractive business opportunities consistent with its rating level.
The following is a broad outline of expected outcomes, recognizing
that there is a meaningful degree of judgment involved in assessing each
Potential for Capital Shortfalls:
In prior research, Moody's identified five monoline financial
guarantor groups as being most exposed to deteriorating performance of
residential mortgage-backed securities: CIFG, FGIC,
SCA, AMBAC and MBIA. Based on further analysis conducted
since early November, we continue to believe CIFG is most likely
to fall below Aaa capital benchmarks, though they have announced
a capital enhancement plan which would significantly reduce that risk.
We also continue to see FGIC, SCA and AMBAC as somewhat likely to
exhibit a capital shortfall under one of the stress models previously
described. And with regard to MBIA, additional analysis of
its direct RMBS portfolio leads Moody's to believe the guarantor
is at greater risk of exhibiting a capital shortfall than previously communicated;
we now consider this somewhat likely. As indicated above,
these analyses will be completed within two weeks.
We would expect to affirm ratings where we are satisfied about both the
firm's capital adequacy and the robustness of its business franchise.
With respect to capital specifically, an affirmation would likely
occur only where the company's capital ratios are above Moody's
benchmarks for the rating level. If capital fell below Moody's
benchmarks, we would assess whether the guarantor's capital
remediation plan was reliably expected to result in the company exceeding
the relevant benchmarks and over what time frame, and communicate
further with the market at that time.
We would expect to review ratings for possible downgrade where the firm's
capital adequacy is less certain over the near term. Specifically,
capital would be below Moody's benchmarks for the rating level and
any capital remediation plan would be either reliable but take longer
to become effective (typically more than one quarter), or shorter
term but less reliable.
Ratings Downgrades without Review:
We would expect to downgrade ratings without initiating a review where
we believe the current rating no longer reflects the long term financial
strength of the firm, even considering the potential benefit of
any credible capital remediation plan. Specifically, capital
would be below Moody's benchmarks for the rating level and any capital
remediation plan would be considered unreliable in returning the company
to capital adequacy consistent with the current rating level.
Assessing Execution Risk of Capital Plans:
There are a number of different vehicles that could well be used as part
of an overall capital plan. Some of these, including quota
share reinsurance, specific excess-of-loss reinsurance,
aggregate excess-of-loss reinsurance, and triggering
contingent capital facilities, may have little execution risk and
could be put in place quickly. Infusion of new capital could also
take multiple forms but have more execution risk, varying based
on the specific nature of the arrangements. The assessment of execution
risk, therefore, will involve judgment that would be difficult
to express in a set of criteria, though we would clearly be conservative
in evaluating the execution risk of any capital plan.
Financial Institutions Group
Moody's Investors Service
Senior Vice President
Financial Institutions Group
Moody's Investors Service
No Related Data.
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