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Bond Insurers

Assured Calls Out S&P Move

The head of the only active U.S. bond insurer on Tuesday objected to the new bond-insurer ratings methodology proposed by Standard & Poor’s, calling it unjustified, irrational, and too subjective.

“Somewhere in this ratings process, reality has to matter,” said Dominic Frederico, chief executive of Assured Guaranty Ltd.

Frederico was reacting to the 39-page proposal Standard & Poor’s issued Jan. 24.

The rating agency is seeking comments on the proposed new criteria, which it said could lead to investment-grade insurers being downgraded “by one or more rating categories … unless those insurers raise additional capital or reduce risk.”

Assured is the only company active in the bond insurance industry. A full category downgrade could be fatal to its public finance business, whose value lies in allowing borrowers to substitute Assured’s rating for their lower credit level.

Shares of Assured Guaranty have fallen more than 30% since Standard & Poor’s stripped the holding company of its AAA rating in late October. Moody’s Investors Service rates both of Assured’s insurer platforms two notches lower at Aa3.

Not only would Assured need to raise $1.9 billion to maintain its current ratings if the new criteria were adopted, but Frederico said the process would mark the third review by Standard & Poor’s in the last 12 months. That simply isn’t justified, considering the company posted record earnings in the first three quarters of 2010, he said.

Assured doubled its shareholders’ equity from roughly $2 billion on Jan. 1, 2008, to $4.2 billion on Sept. 30, 2010, according to Frederico. “When I say reality has to be considered in the rating process, that’s the reality I focus on,” he said.

One proposal introduced by Standard & Poor’s is a leverage test. Under the new criteria, a triple-A rated insurer would have to carry a maximum leverage ratio of 75:1 on its municipal book and 20:1 for structured finance policies.

According to JPMorgan analysts Chris Holmes and Alex Roever, Assured’s mixed portfolio — 75% of which wraps public finance debt — would require a leverage ratio of 66:1, 77:1, or 97:1 to achieve triple-A, double-A, or single-A ratings, respectively.

Its actual leverage ratio was 101:1 as of the third quarter, the analysts wrote, suggesting that Assured’s rating under the new criteria could be A or even A-minus.

Frederico said that’s only so because the leverage test is deficient in that it ignores the credit quality and duration of any bonds it insures.

“It’s a total par against capital,” he said of the leverage test. “If the par is made up of all triple-A exposures versus triple-B exposures, the leverage test doesn’t seem to differentiate.”

The same goes for structured-finance policies, so that collateralized loan obligations — which performed fairly well during the recent financial crisis — would require the same capital backing as toxic mortgage-backed securities.

Some refinement in that area could help Assured because 45% of its insured portfolio — which totals $617 billion par outstanding — carries an underlying rating of double-A or higher, a presentation to investors showed.

Those figures include holdings in its two insurer subsidiaries — Assured Guaranty Corp. and Assured Guaranty Municipal Corp. — and its reinsurer called Assured Guaranty Re.

The leverage test also doesn’t allow insurers to include unearned premium reserves as part of its capital base, even though all costs for public finance wraps are paid up front.

Assured’s statutory capital was $4.94 billion in its earnings statement for Sept. 30. If loss reserves and unearned premiums are also included, its capital base would be $10.3 billion.

Those reserves are “available — as any premium is — to pay expenses, losses, and to result in profits,” Frederico said, calling their exclusion by Standard & Poor’s an oversight.

In general, efforts to revise rating criteria should be applauded, he added, but these proposals aren’t helping to clarify the process or ensure ratings are consistent over time. He said that of the 49 separate rating criteria within the proposed methodology, 65% are subjective in nature.

“The current proposal needs more refinement in order to be a more analytically supportable approach to rating our industry and provide greater clarity and justification for the measures used and the processes employed,” Frederico said.

Standard & Poor’s didn’t return calls to comment but is hosting a conference call on the proposal Wednesday. It is also seeking opinions on the proposal until March 25.

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