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Announcement:

Moody's affirms Financial Security Assurance at Aaa

11 Mar 2008
Moody's affirms Financial Security Assurance at Aaa

New York, March 11, 2008 -- Moody's Investors Service has affirmed the Aaa insurance financial strength ratings of Financial Security Assurance Inc. and its affiliated insurance operating companies. Moody's has also affirmed the Aa2 senior unsecured ratings of parent company, Financial Security Assurance Holdings Ltd. These rating affirmations reflect Moody's assessment of FSA's strong capital position despite some deterioration in its HELOC book, as well as the firm's strengthened market position. The rating outlook remains stable.

OVERVIEW OF RATING APPROACH

As outlined in Moody's Rating Methodology for Financial Guarantors, we have evaluated FSA along five key rating factors: 1) franchise value and strategy, 2) insurance portfolio characteristics, 3) capital adequacy, 4) profitability, and 5) financial flexibility.

Of these factors, capital adequacy is given particular emphasis. To estimate capital adequacy, Moody's has applied its traditional portfolio risk model for determining stress losses on the non-mortgage related portion of FSA's insured portfolio and alternative stress tests for the mortgage and mortgage-related CDO exposure. For mortgage-related exposures, stress losses were estimated using assumptions consistent with a scenario where 2006 subprime first lien mortgages realize an average of 21% cumulative pool losses, with other vintages and products stressed accordingly. Stress-level losses for RMBS transactions were assessed on a transaction-by-transaction basis.

Losses estimated under the approach described above were present valued to reflect estimates of the payout pattern that would emerge, based on the collateral type. These factors resulted in aggregate present value discounts to principal loss estimates of approximately 8% for RMBS. (FSA's two ABS CDO exposures did not generate any loss under Moody's 21% stress scenario.) Non mortgage risks are discounted within the portfolio model based on estimates of payout patterns as well.

In comparing estimated stress losses to claims paying resources and associated rating levels, Moody's combines an estimated loss distribution for mortgage risks with one for non-mortgage risks, assuming a correlation between the two that ranges from 90% (for Aaa) down to 30% (for Baa3). Claims paying resources are then compared to the indicated capital need, at the target benchmark (1.3x capital needed to cover stress-case losses).

KEY RATING FACTORS -- CAPITAL ADEQUACY

Based on the risks in FSA's portfolio, as assessed by Moody's according to the approach outlined above, estimated stress-case losses would be in the range of $4.5 billion, including approximately $1.1 billion from its mortgage exposures, with home equity lines of credit (HELOC) being the main contributor. This compares to Moody's estimate of FSA's claims paying resources of approximately $6.5 billion, resulting in a total capital ratio of over 1.4x, which exceeds the 1.3x Aaa "target" level. Moody's further noted that in the most likely or "expected" scenario, FSA's insured portfolio will incur lifetime losses of approximately $1.2 billion in present value terms, and that FSA's current claims-paying resources cover this expected loss estimate by over 5x.

In February 2008, FSA received a $500 million capital injection from its parent, the Dexia Group, to shore up the guarantor's financial resources, helping the firm maintain capital resources above Moody's "target" total capital ratio at a time of high underwriting growth for the firm and greater credit uncertainty.

KEY RATING FACTORS -- BUSINESS AND FINANCIAL PROFILE

In Moody's opinion, the current level of stress in the market has benefited FSA's business prospects relative to many of its peers, who have experienced a decline in market share in light of credit concerns over large ABS CDO and mortgage exposures. FSA has been able to take advantage of the current environment by generating high quality business at historically strong premium rates. FSA's broad and deep relationships with issuers, as well as its prominent market position and execution capabilities in several market sectors, provide the company with a solid foundation from which to capitalize on today's market conditions. The rating agency added that FSA's large underwriting volume is also an important indicator of the perceived value of financial guaranty insurance by the capital markets more generally. Financial guarantors perform a valued credit and underwriting intermediation function that has translated into improved market pricing and liquidity for the insured securities. Moody's believes, however, that FSA's current competitive strength is likely to weaken somewhat as financial market conditions normalize and as certain other guarantors gain or regain market traction.

With respect to underwriting and risk management, Moody's believes that FSA's conservative underwriting strategy has resulted in a generally high-quality and well-diversified insurance portfolio, but that single risk and sectoral concentrations such as those evidenced by the company's second lien mortgage portfolio will need to be monitored closely going forward.

Moody's added that, while FSA's ABS CDO exposure is modest, the company has approximately $80 billion of exposure to pooled corporate debt obligations (CDOs). The majority of this exposure is in synthetic form, with the rest being CLOs and to a smaller extent mostly older vintage CBOs. The rating agency believes that the risks presented by such exposures are manageable by FSA given the conservative underwriting strategy of the firm, with all deals originated since 2003 being Aaa at origination or attaching above Aaa subordination levels in the case of synthetic transactions.

Moody's also believes that the company's non-core asset management activities, including GICs, place incremental negative pressure on its ratings. The rating agency noted that FSA had to correct a material weakness in internal controls over financial reporting of hedging transactions in 2005, and that it recently received a Wells Notice from the SEC. The SEC staff is considering recommending a civil injunctive action and/or administrative proceedings against FSA, alleging violations of some anti-fraud provisions of the Securities Exchange Act of 1934 and Securities Act of 1933. This action by the SEC follows a lengthy investigation of practices in the municipal GIC market. FSA, along with other financial institutions, received a subpoena from the SEC in November 2006. The U.S. Attorney's Office for the Southern District of New York has also been pursuing a criminal investigation into these matters. Moody's will continue to follow the situation for material developments.

FSA's near term profitability is expected to be somewhat volatile, as new business production is likely to remain strong for some time and as possible additional credit losses are realized. However, some earnings stability is provided by the company's large in-force portfolio, which will continue to provide significant premium revenue for years.

In terms of financial flexibility, FSA, like other financial guarantors, benefits from its ability to pay claims over an extended period of time, typically scheduled interest and principal at maturity. Moody's said that FSA's ownership by Dexia is considered to be a strength, as evidenced by its capacity and willingness to provide FSA with additional funding at a time when some publicly traded guarantors were struggling to raise capital in very challenging market conditions. Moody's believes that holding company liquidity is adequate, supported by dividend capacity from Financial Security Assurance Inc.

OVERVIEW OF FINANCIAL SECURITY ASSURANCE

Financial Security Assurance, Inc. is the main operating company of Financial Security Assurance Holdings Ltd. (FSA Holdings, Aa2 senior debt rating) and the parent of other wholly-owned financial guaranty insurers in a stacked structure. FSA Holdings is a subsidiary of Dexia Credit Local (senior debt at Aa1, BFSR at B+), which is the largest operating company within the Dexia Banking Group.

New York
Jack Dorer
Managing Director
Financial Institutions Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Stanislas Rouyer
Senior Vice President
Financial Institutions Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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