Moody's reviews FSA's Aaa rating for possible downgrade
New York, July 21, 2008 -- Moody's Investors Service has placed the Aaa insurance financial strength
ratings of Financial Security Assurance Inc. (FSA) and its affiliated
insurance operating companies on review for possible downgrade.
In the same rating action, Moody's also placed the senior unsecured
ratings of parent company, Financial Security Assurance Holdings
Ltd. (Aa2-rated) on review for possible downgrade.
Today's rating action reflects elevated risks with the financial guaranty
insurance market and within FSA's insured portfolio. Moody's
said that FSA's credit profile may no longer be consistent with the Aaa
rating, given the materiality of the stress faced by the firm in
its insurance and asset management operations, uncertainty about
the firm's portfolio risk profile, material shifts in the
demand function for financial guarantees, and -- as observed
recently among FSA's competitors -- potential sensitivity of
its franchise and financial flexibility if losses continue to rise.
Moody's noted that, while the outcome of the review is uncertain
at this time, a downgrade of FSA's insurance financial strength
rating below Aa2 is currently seen as unlikely.
As a result of this review, the Moody's-rated securities
that are guaranteed or "wrapped" by FSA are also placed under review for
possible downgrade, except those with higher public underlying ratings.
A list of these securities will be made available under "Ratings Lists"
CAUSES OF THE REVIEW FOR DOWNGRADE
Moody's said that significant deterioration in the financial conditions
of both insurance and asset management operations of FSA, as assessed
by our updated analysis discussed below, may be inconsistent with
the expectations of a Aaa-rated insurance company given the operational
and strategic sensitivities that such stress may exemplify. As
losses have mounted in the US residential mortgage market, FSA has
avoided the source of the guarantors' greatest stress, namely
ABS CDOs. However, its exposure to direct RMBS has generated
material losses in its insurance and asset management operations.
Moody's has also previously noted operational risks, exemplified
by FSA's receiving a Wells Notice from the SEC related to its asset
management operations. Dexia, FSA's parent, has
materially mitigated the financial effect of the firm's recent losses
through its $500 million capital infusion and extension of a committed
$5 billion, five year, line of credit, however
such support may not be unconditional or sufficient to entirely mitigate
potential risks, commented the rating agency.
According to Moody's, recent events have demonstrated that
the leverage and complexity of some structured finance transactions have
made loss estimations for certain segments of FSA's insured portfolio
more difficult and the variability of those estimations, especially
given the guarantor's operating leverage, may be inconsistent
with the very low risk tolerance implied by a Aaa rating.
Moody's added that the review for downgrade also reflects the significant
reduction in overall market demand for financial guaranty enhancement.
The structured finance market that generated about half of the industry's
and FSA's new business has seen a dramatic decline as a result of
the current market dislocation. Such dramatic instability in the
firm's current and prospective market opportunity also raises questions
about whether a Aaa rating remains appropriate.
Bond insurance volumes in the municipal segment have also declined significantly,
with insurance penetration rates dropping by a third or more. Although
deterioration in the credit profile of some of the large financial guaranty
providers might have been the main factor prompting this shift,
and FSA's competitive position in this market has improved,
Moody's notes that alternatives to bond insurance and the potential
reassessment of risk by investors in this segment may negatively influence
demand in this sector in the future.
The recent market disruptions and resulting decline in equity valuations
of other financial guarantors have highlighted the extent to which the
market's perception of future adverse developments can impact not
only new business volume but also financial flexibility. In this
context, Moody's takes note of the potential fragility of
FSA's access to business opportunities and capital should its insured
portfolio unexpectedly deteriorate.
According to Moody's, FSA is one of only three guarantors
that have remained active in recent months, reflecting the market's
perception of FSA's lower risk profile relative to many of its peers
given the company's limited exposure to ABS CDOs and strong parental
support. FSA has become the leading municipal underwriter with
currently about a 60% market share of the insured market (approximately
20% to 25% of current origination), although increasing
mortgage-related losses could adversely affect the firm's
franchise going forward.
Following Moody's May 14th press release on FSA, the rating
agency has reassessed FSA's mortgage-related exposures in
light of worse-than-expected performance trends in the second
lien asset class, and meaningful credit deterioration of mortgage
investments held by the firm's Financial Products portfolio.
Based on Moody's revised assessment of the risks in FSA's
direct RMBS portfolio, expected losses on a present value basis
approximated $770 million, while stress-case losses
totaled $1.5 billion, an increase of 78% and
36% respectively from Moody's prior estimates. Most
of this increase is attributable to material deterioration in the firm's
HELOC and closed-end second lien portfolio. Furthermore,
FSA remains modestly exposed to the ABS CDO sector, which did not
generate any loss under Moody's stress scenario.
Moody's said that FSA's conservative underwriting strategy has resulted
in a generally high-quality and well-diversified insured
portfolio beyond the firm's mortgage-related exposures.
Most non-mortgage-related structured segments are performing
well, although certain exposures, such as FSA's $75
billion of pooled corporate exposures, may be more sensitive to
transaction or sector deterioration. The rating agency added that
FSA has a $150 million exposure to Jefferson County Alabama that
could lead to losses to the guarantor given the severity of the stress
faced by the issuer.
FSA's asset management business has also experienced credit deterioration
given the large concentration of RMBS risk held within its $18
billion Financial Products portfolio. The rating agency said that
base-case losses within the Financial Products portfolio are expected
to be modest, but Moody's stress-case loss estimates
exceed $600 million, representing a capital charge increase
of roughly $200 million from prior assessments. FSA recently
entered into a $5 billion 5-year bank line with its parent
to mitigate the impact of asset liability mismatches relating to current
mark-to-market losses within the GIC portfolio. Moody's
said that without this line, capital charges for the Financial Products
business would have been materially higher.
Moody's has re-estimated expected and stress loss projections
on FSA's aggregate insured portfolio. Based on Moody's
revised assessment, estimated stress-case losses would approximate
$5.1 billion at the Aaa threshold and $4.2
billion at the Aa2 threshold. This compares to Moody's estimate
of FSA's total claims paying resources of approximately $6.5
billion. Relative to Moody's 1.3x "target"
level for capital adequacy, FSA is currently estimated to be $140
million below the Aaa target level.
SCOPE OF THE REVIEW
Moody's said that it will review the characteristics of FSA's
portfolio, particularly within the structured segment, that
could make the company susceptible to material losses as seen in the mortgage
market. Moody's will also evaluate the company's business
and franchise sensitivity to an erosion of market confidence, including
any impact on financial flexibility. In addition, Moody's
review will consider the likely strategic direction of the firm given
the changing dynamics within the industry, as well as the potential
implications of any future regulatory changes to the credit profile of
Moody's said that it will also consider the potential actions that
FSA may undertake to strengthen its financial profile given the currently
estimated shortfall to Moody's Aaa target level for capital adequacy
and remaining uncertainty about the performance of mortgage related exposures.
In this context, an important consideration will be the nature of
the prospective support for FSA by Dexia.
The following ratings have been placed under review for downgrade:
Financial Security Assurance Inc. -- insurance financial
strength at Aaa;
Financial Security Assurance (U.K.) Limited --
insurance financial strength at Aaa;
Financial Security Assurance Intl Ltd. -- insurance
financial strength at Aaa;
Financial Security Assurance Holdings Ltd. -- senior
unsecured debt at Aa2, junior subordinated debt at Aa3, provisional
senior debt at (P)Aa2, provisional subordinated debt at (P)Aa3,
and provisional preferred stock at (P)A1;
FSA Seguros Mexico S.A. de C.V. --
insurance financial strength at Aaa (the firm's Aaa.mx national
scale rating was affirmed with a stable outlook); and
Sutton Capital Trusts I, II, III and IV -- contingent
capital securities at Aa2.
Financial Security Assurance, Inc. is the main operating
company of Financial Security Assurance Holdings Ltd. 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.
Senior Vice President
Financial Institutions Group
Moody's Investors Service
Financial Institutions Group
Moody's Investors Service