As the monoline bonds insurers work to keep or regain their triple-A ratings, the capital models employed by the rating agencies have come into ever greater focus and, in some cases, led the insurers to ask for the withdrawal of the ratings tied to those models.
On Friday, MBIA Inc. asked Fitch Ratings to remove its insurer financial strength rating for six subsidiaries, including its financial guarantor, MBIA Insurance Corp. MBIA said market dynamics have elevated the IFS ratings beyond the guarantees they are meant to provide and made the volatility of Fitch's rating a liability for the bond insurer.
In a letter to Fitch, MBIA chief executive officer Jay Brown said the IFS ratings have become a measure followed closely by equity investors and traders of credit default swaps, which bet on MBIA's chances of default, and that MBIA was taking action to reduce the volatility in the ratings, and by extension equity and debt instruments.
MBIA also asked Fitch to continue rating its debt, saying it would work with Fitch to provide appropriate information and disclosure.
In a subsequent letter, Fitch CEO Stephen Joynt offered to provide ratings for MBIA-insured issues free of charge, while questioning the intentions behind MBIA's request. Joynt challenged Brown's assessment of the standing of IFS ratings in the market, suggesting that if Brown really thought the ratings were a distraction he would ask for Standard & Poor's and Moody's Investors Service to withdraw them as well.
"It would appear that rather than 'work with Fitch,' your intention could be to emasculate our opinion by withholding information and subsequently discredit our opinion as being uninformed," Joynt said.
Joynt also suggested that with Fitch's ongoing analysis, MBIA may be worried that it would be downgraded by the rating agency below AAA, an assertion that Brown had earlier denied.
At the heart of MBIA's request is the model used by Fitch to judge the capital adequacy and IFS rating for each financial guarantor.
Several years ago, Fitch developed a capital model called Matrix, in conjunction with Milliman Inc., a large consulting and actuarial firm. Fitch first hired Milliman in 2004 to help it develop Matrix, which assesses the risk portfolio of the financial guarantors.
"I think there is a big benefit to having third party consultation," said Keith Buckley, group managing director and global head of the insurance group.
According to MBIA's letter, the model uses Fitch's data as well as that of MBIA and the other rating agencies as input. Part of that model was a default study, which established the parameters of the model used to rate the bond insurers, MBIA said.
However, MBIA's issue is that because Fitch only rates about a third of the issues that MBIA insures, it relies on the ratings of the other two agencies to arrive at its rating. In doing so, the model chooses to look at the lower of the ratings, resulting in inappropriately high capital requirements for the bond insurer, MBIA said.
Buckley said a copy of the model was sent to all of the bond insurers, so that they could run their data and portfolios through it. However, when the insurers arrived at very different capital reserve requirements, several of them asked to see parts of the model which Fitch could not disclose because it involved Milliman's intellectual property, Buckley said.
MBIA is not the first financial guarantor to ask Fitch to withdraw its IFS rating. In September, Radian Asset Assurance also asked to have its IFS rating withdrawn. At the time, Fitch had downgraded Radian to A-plus from AA, with a negative watch.
In a Sept. 27 conference call, Radian Asset president Stephen Cooke said his company had been in talks with Fitch about the Matrix capital model since the beginning of 2007.
"Fitch's new model considerably diverges from other rating agency and industry models, as well as our own internal capital model," Cooke said in the call.
Radian's problems with the model were related to the treatment of high attachment AAA collateralized debt obligation risks. At the time, according to a September presentation on Radian's Web site, Fitch acknowledged that "market participants have suggested that Matrix may be overly punitive in its treatment of CDOs at levels materially above minimum AAA thresholds."
At the time of Radian's request for withdrawal, Fitch said it knew the Matrix model took a different, more conservative approach. But Fitch said at the time, and Buckley reiterated, that these differences are the model's strength.
"I think it is very true that our model is producing somewhat different results than a number of the guarantors are used to," Buckley said. "Our contention is that it's actually producing more reliable and better results."
The capital and rating models for all of the rating agencies have come under criticism recently because of downgrades and threats of downgrades about the bond insurers. The management at the financial guarantors and their holding companies have insisted that their capital reserves are sufficient for maintaining a triple-A rating, while the rating agency models often say otherwise.
On Feb. 5, Fitch placed MBIA on negative watch just weeks after upgrading the company's rating to AAA, with a stable outlook.
At the time, market sources expressed surprise at the outlook change, attributing it to changing estimates of the capital needed to cover any potential losses and keep the bond insurance rating at triple-A. It is the volatility of these capital requirements that has led MBIA to ask Fitch to drop its rating.
"We have very little idea why Fitch's capital model produces the charges it does, and why it can change so rapidly at any point in time," Brown said in a letter to Fitch, dated March 9.
Some of the rating changes have come because of changes related to increased loss estimates for the CDOs and credit derivatives insured by the bond insurers, a moving target a final tally of which had yet to be seen. Other rating changes have been accompanied by concerns about the future of bond insurance and the ability of the financial guarantors to write new business.
So far, Fitch has not withdrawn its rating for Radian and made no indication that it would for MBIA either. While the final decision to withdraw or maintain the IFS ratings lies with Fitch, MBIA could cease to make information available to Fitch and thus make rating the bond insurer difficult or impossible, the rating agency said.
"Ultimately, having models that say different things is of great value," Buckley said.