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Assured to Market: It's Not All Negative

Assured Guaranty Ltd. yesterday sought to reassure investors about its future, while market participants considered the possibility of a municipal market with no more bond insurers rated triple-A by all three major rating agencies. This came one day after Moody's Investors Service announced it had put both Assured Guaranty Corp. and Financial Security Assurance Inc. on watch for possible downgrade.

Even as market participants contemplated the end of the bond insurance business in its current form, Assured said it believed the market will see past the headline of Moody's announcement and continue to use its services.

"The most important thing is to distinguish substance from form," Assured Guaranty president Michael Schozer said. "I don't believe we were out there selling Moody's rating. We were selling our balance sheet."

Moody's announced Monday night it had placed both FSA and Assured on watch for possible downgrades from their existing triple-A ratings because of "elevated risks with the financial guaranty market" and within each company's insured portfolio.

Although both companies had largely avoided exposure to the collateralized debt obligations of asset-backed securities that plagued previously downgraded insurers, Moody's cited the shrinking demand for bond insurance and the difficulty and variability of loss estimations on certain products, which "may be inconsistent with the very low risk tolerance implied by a Aaa rating".

In regards to Assured, Moody's noted that the company exceeds the rating agency's 1.3X target for capital adequacy at the triple-A level by $120 million. Its revised estimate of stress-case losses on Assured's entire portfolio at a triple-A level would approximate $1.7 billion, compared to Assured's total claims-paying resources of $2.4 billion, Moody's said.

Moody's estimated present value stress-case loss estimates on direct residential-mortgage based securities of $330 million for Assured and $250 million for AG Re - Assured Guaranty Ltd.'s double-A rated reinsurer - little changed from previous tests. But Moody's expressed concern about the future of Assured's $40 billion of pooled corporate exposures, which "may be more sensitive to transaction or sector deteriorations." Assured countered in a conference call held yesterday morning that Moody's rates 95% of that portfolio, and 84% sits at a Aaa level.

Executives at Assured said they believed Moody's action is more about the rating agencies view on the entire bond insurance market, rather than Assured itself.

"We meet Moody's triple-A capital requirements; therefore I believe the portfolio is extremely strong, well diversified, and very well underwritten," said Dominic Frederico, chief executive officer of Assured Guaranty Ltd. Later he added about the corporate CDOs: "It would be different if they didn't rate it or it wasn't rated triple-A currently. These are absolute ratings as of today. So I struggle with the model to be honest with you."

The company also reported estimated earnings for the second quarter ending June 30. The company expects to report between $515 million and $565 million in income, thanks to after-tax unrealized gains on credit derivatives of between $475 million and $525 million.

Even with Assured's comments, the stock plunged nearly 40% yesterday to $11.32 at the close, although it rebounded slightly from a loss of more than 50% earlier in the day. Andrew Wessel, an analyst with JPMorgan, also downgraded the stock to neutral from buy, writing in a report that "although we view the commentary from Moody's as extremely vague, we feel the rating agency is taking an ultra-conservative stance given its sustained misjudgment of the larger and more troubled bond insurers over the last 12 months."

But investor Wilbur Ross - who agreed to invest $1 billion in the company in February - backed Assured in an interview with Bloomberg TV. He has already invested $250 million, but a downgrade would give him the option of withholding a $750 million portion.

"There is no real justification for this review process, let alone for an actual downgrade," Ross said. "I believe the outlook for the company is extraordinarily good."

Regarding FSA, Moody's outlook was less optimistic, noting FSA falls $140 million short of the 1.3X target for capital adequacy for a triple-A level. Moody's revised stress-loss projections would approximate $5.1 billion at the triple-A level, compared to FSA's estimated $6.5 billion in claims paying ability.

Moody's cited increased estimates of present value and stress-loss levels in FSA's direct RMBS portfolio, its $150 million in exposure to Jefferson County, Alabama, and its financial product portfolio as part of the reasons for its concerns. Dexia SA, FSA's parent, recently saw its rating outlook changed to negative by Standard & Poor's and Fitch Ratings due to worries about the impact of the deteriorating U.S. housing market on FSA's earnings.

FSA said it will work with Moody's to allievate any concerns.

"We take note of the concerns Moody's has expressed, and we will work closely with them to reestablish our Aaa-stable claims-paying ratings," Financial Security Assurance Holding Ltd. president and chief executive officer Robert Cochran said in a statement.

Moody's said it was unlikely either insurer would be downgraded below Aa2. But market participants expressed surprise about the actions, suggesting such an aggressive tone would not have been taken as recently as six months ago. Some suggested it could spell the end to the bond insurance market in its current form.

The Moody's report implies that the traditional triple-A business models of monoline insurers "cannot be profitable enough to justify the capital necessary to earn" the rating, wrote Guy LeBas, fixed-income strategist for Janney Montgomery Scott LLC.

"It's not so much capital adequacy that's the problem, as the monoline business model," LeBas said in an interview. "In issuing these reviews, Moody's is effectively questioning whether the monoline business model can exist."

Assured said issuers, especially, small- and medium-size ones, will still require some form of credit enhancement in the future. Even if it does eventually get downgraded, it noted it has worked at a split ratings level before. It believes its balance sheet still puts in position to do business.

"The hypothetical that this is the end of bond insurance flies in the face of the facts of investor demand for credit enhancement in the muni market from financial institutions rated double-A and higher," Schozer said, later adding, "I've been around for too long and gone through too many cycles to overread these kind of things as some sort of systemic change in the demand for credit enhancement."

Even if the market does accept a double-A rated insurer, though, it can't be expected to look past ratings, market participants said.

"It's just about the rating," said Matt Fabian, managing director of Municipal Market Advisors. "For the kind of credits that they want to wrap, if they were credits with actual default risks, then their own claims paying ability is important. But if it's credit with a very small default risk like safe-sector municipals, then it's really more about the rating. It needs to have a stable rating."

The threat of downgrades already had an impact as market participants have adjusted to the news. A number of issuers delayed pricing because of the news or simply sent bonds out without insurance, market participants said. Pennsylvania Turnpike Commission officials, for instance, decided to postpone - for one day - a $235 million subordinate revenue bond deal with Assured as insurance provider, originally set to price yesterday. Instead, Merrill Lynch & Co will sell the bonds today.

The Kentucky Economic Development Finance Authority delayed settlement on $78.7 million in Louisville Arena Project Revenue Bonds insured by Assured Guaranty and said it will update its disclosure because of Moody's decision.

In the secondary market, bonds wrapped by Assured and FSA were slightly weaker than the market as a whole, trades reported to the Municipal Security Rulemaking Board showed.

No matter what the eventual outcome, market observers agree this won't make it any easier to get work done.

"We could really have within the next couple weeks, no sufficient capacity for the municipal market," said Rob Haines, a senior analyst with CreditSights. "What does that do? Maybe it slows down muni issuance, maybe we shift to a model where people accept a double-A wrap. But even if you accept a double-A wrap, you're going to be doing it at a higher financing cost to municipalities, and municipalities, this is a time when their coffers are running dry anyway, so it's just not good for anyone really."

Michelle Kaske and Michael Scarchilli contributed to this story.

 

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