The worst may not yet be over for already beleaguered bond insurers, as their exposure to residential mortgage-backed securities and collateralized debt obligations on asset-backed securities will continue to plague them, Fitch Ratings said in a special report on financial guarantors it released last week.
The potential losses on these securities help make the industry's near-term outlook negative and its intermediate future uncertain, according to Fitch.
"Fitch is concerned that continued erosion in underlying RMBS can cause further deterioration in the insured portfolios over and above current expectations and even Fitch's most stressed assumptions," the report said. "Such occurrences would be expected to put further pressure on existing ratings, and could potentially result in insolvencies for the weaker players."
Fitch estimates that between the five downgraded bond insurers it analyzed - Ambac Assurance Corp., CIFG Assurance NA Inc., MBIA Insurance Corp., Financial Guaranty Insurance Corp., and Security Capital Assurance Ltd. - aggregate expected-case, present-value losses on structured finance CDOs will ultimately total between $15 billion and $21 billion. Between the four subprime-exposed insurers that had reported financial results through March 31, just $6 billion in reserves or permanent impairment charges had been made.
The insurers also have significant direct exposure to the RMBS market. Even Financial Security Assurance Inc. - which largely avoided exposure to the market of credit default swaps on asset-backed securities - has recently taken added loss reserves on its second-lien home equity line of credit and Alt-A portfolios.
Fitch said these exposures will continue to put pressure on the five downgraded insurers it reviewed. Although the best positioned insurers - Assured Guaranty Corp. and FSA - better managed their exposures to the U.S. mortgage markets, Fitch warned that changes in criteria by all the rating agencies may increase capital requirements, challenging these insurers, too.
Just a few days after the Fitch report's release, Moody's Investors Service Monday put both triple-A insurers on review for downgrade.
"Given the fact that it is such a ratings-sensitive business, we wanted to just call into question that any existing company is going to have to have to, obviously, manage their way through whatever changes might occur that might theoretically impact their relative position in the marketplace," Fitch managing director Tom Abruzzo said in an interview yesterday.
Fitch said it is also considering changes to its ratings methodology to better assess risks and ensure the stability of its ratings. Changes could include greater review of contingency plans, tighter capital requirements and more qualitative evaluations of insurers. It said it would also consider re-evaluating the "historical belief that shareholder and policy interests will be aligned in times of stress," noting that management may devote capital to other business opportunities - such as a new muni-only insurer - at the expense of existing policyholders.
In light of decisions by some insurers to withhold information and ask Fitch to withdraw its rating, the agency also said it may develop a ratings model based on publicly available information.
"It is reiterating that if we believe that there's means, methodologies, or a way ultimately that we can provide an opinion on a player through information that ... we can publicly get our hands on, then we would seriously consider providing those opinions publicly," Abruzzo said. "We're not suggesting we have a method in place that we're going to be rolling out in a week or two. It's just that if we believe we can do so, we will give complete and full consideration to it."
