Sell Side

Assured Guaranty to Buy FSA From Dexia

Assured Guaranty Ltd. Friday agreed to purchase Financial Security Assurance Holdings Ltd., excluding its financial products business, from Franco-Belgian bank Dexia SA, making another major change to an already radically transformed bond insurance industry.

The $722 million deal - composed of cash and stock - will bring under one roof the two largest providers of bond insurance this year. It also continues the growth of Assured Guaranty, whose bond insurer subsidiary Assured Guaranty Corp. ranked near the bottom of the insurance tables for 2007 and only became rated triple-A by all three credit agencies in the middle of that year.

"I think we had have a unique opportunity, we now can attack or at least fight back into the marketplace versus being fought against," Dominic Frederico, president and chief executive officer of Assured Guaranty, said in a conference call with investors. "The breadth and financial strength of the company is without question, and it's nice to look to a market where we think and know we really add significant value."

Assured will acquire FSA for $361 million in cash and 44.6 million common shares, buying FSA for 37.5% of its book value. Assured will issue common stock to finance the cash portion of the transaction, with funds affiliated with billionaire Wilbur Ross' W.L. Ross & Co. - already a major investor in the firm - agreeing to provide a backup investment commitment for the offering. Assured will also assume $730 million in FSA's outstanding debt.

The deal excludes FSA's troubled financial products unit. Even though the Financial Securities Assurance Inc. backed the guaranteed investment contracts in that portfolio, Dexia and the governments of France and Belgium will assume all financial responsibility and risks for the business.

As of Sept. 30, FSA's insured portfolio had net par outstanding of $423.9 billion, with 74% related to public finance and the rest to structured finance. The companies' combined book would have a net par outstanding of $651.3 billion, with 66% related to public finance.

As result of the deal, Dexia will become a 24.7% shareholder in Assured, although Assured can increase the amount of cash it pays, lowering that total. During a conference call with investors, Dexia chief executive officer Pierre Mariani said he expects to be a passive investor in Assured, and could look to sell its stake once its twelve-month lock-up period expires.

The deal needs approval from regulators, but Frederico said in an interview with The Bond Buyer that the insurance departments in New York and Maryland had been "extremely supportive." A spokeswoman from the Maryland Insurance Administration said it would review the deal when the appropriate files came in. New York insurance superintendent Eric Dinallo said in a statement the deal should help stabilize both companies, which is "good for their policyholders and for the municipal bond market."

The companies will also need approval on antitrust considerations, but lawyers from both firms agreed it should not be an issue, Frederico said. Issuers have the option to use other forms of - or no - credit enhancement, and the business has relatively low barriers to entry, he said.

The deal also hinges on the rating agencies confirming the acquisition will not have a negative impact on the ratings of FSA or Assured. Fitch Ratings Friday said it did not expect the deal would have a negative impact on the ratings of either company.

Moody's Investors Service said it will consider the potential impact of the transaction on the ratings of the companies in the context of its ongoing reviews of both Assured Guaranty Corp.'s and Financial Security Assurance Inc.'s Aaa ratings, which it expects to finish in the "near term". Moody's noted the steps Dexia has taken with the European governments to mitigate the risks of FSA's asset management business.

Assured Guaranty Corp. currently has a triple-A rating from all three agencies, with its rating from Moody's on review for downgrade since July 21. Financial Security Assurance Inc.'s triple-A rating is on review for downgrade at Moody's, and on negative watch at both Standard & Poor's and Fitch.

The transaction will "soften what had been a very likely downgrade scenario for FSA and Assured holders," said Matt Fabian, managing director at Municipal Market Advisors.

Assured shareholders must also approve the deal, which is expected to close within three to sixth months.

Frederico cited a number of reasons the deal looked attractive. Assured picks up FSA for just a portion of its book value, gets FSA's "robust" future earnings stream, and brings on a talented group of people that Assured always considered among the industry's "best and brightest," Frederico said.

In addition, the deal keeps FSA and its experienced employees from falling into a competitor's hands, Frederico said. Warren Buffett's Berkshire Hathaway Assurance Corp. - which has maintained a limited presence in the primary market - had also been rumored as a potential buyer of FSA.

Frederico said in the conference call that he sees the ability to integrate the staffs and eliminate redundant expenses in areas such as technology, administration, systems, and accounting. Assured estimates synergies of up to 25% of FSA's operating expenses, it said in a presentation on its Web site.

On the underwriting side, Frederico said the companies mesh well because of their different areas of expertise. Assured focused more on smaller issues, more complex structures and areas such as health care and private higher education. FSA worked with larger issuers and general obligation credits, he said.

The companies will both maintain their regulatory licenses, and each will continue to write new business. Frederico noted FSA has already said it will write only public finance business in the future.

"Both companies will still trade, so you'll still have two balance sheets, two capital bases, two sets of ratings, so that the capacity can be allocated or shared between the two," he said. "Both companies are fighting a marketplace that has shifted to other supports or uninsured, and that's got to take some time for us to re-establish the value that the financial guaranty industry has always provided and get a better share of the marketplace."

Thanks to the deal, Assured should have "better prospects to write a fuller slate of business to tighter spreads," Fabian said. To the extent the deal stabilizes the valuation of Assured, the insurer should be able to underwrite more public finance risks, which could help issues with more limited market access, such as hospitals, small revenue systems, and universities, Fabian said.

Assured Guaranty stock close up 4.57% on Friday to $8.47 on a day when the broader markets fell. Analysts at Fox-Pitt Kelton Cochran Caronia Waller kept its "in line" rating on the stock, but said the stock looked "attractive" for a time horizon of beyond a year.

"This transaction transforms the company to a dominant player in the market, and makes the long-term outlook for the company's performance materially better," analysts Gary Ransom and Amit Kumar wrote.

As the only two bond insurers to avoid large exposures to collateralized debt obligations of asset-backed securities, Assured and FSA benefited from downgrades to other insurers. FSA ranks as the market's top insurer this year, wrapping 1,362 issues with a par value of $38.6 billion, according to Thomson Reuters. Assured ranks second - wrapping 802 issues with par value of $23.6 billion - after backing just $3.7 billion worth of issues all of last year.

But FSA's other exposures to the U.S. housing market began to weigh it down, and Dexia had to extend help to it and its financial products unit earlier this year. After European governments helped prop up Dexia amid the global credit crisis in October, the board of directors gave a mandate to its new chief executive officer to reduce the company's exposure to the risks at FSA.

Dexia yesterday announced the deal as part of strategic plan while reporting a third quarter net loss of approximately 1.544 billion euros, or $1.97 billion. FSA Holdings reported a third-quarter net loss of $333.5 million, primarily due to other-than-temporary impairment charges to the financial products investment portfolio, losses related to residential mortgage-backed securities exposure, and negative fair-vale adjustments on insured derivatives.

"The sale of FSA for me is absolutely important - it was a major risk for the group, it was a major exposure to the most risky components of the asset-backed business in the U.S. and clearly the scope today helped us reduce and contain this risk," Mariani said.

FSA chairman and chief executive officer Robert Cochran praised the transaction with Assured in a statement.

"We believe that this combination is a win-win for issuers and investors, as well as for the two companies," he said "The whole will be greater than the sum of the parts based on the exceptional talents of our people, the larger scale of operation and greater capital strength achieved."


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