Fitch Ratings has placed Financial Security Assurance (FSA) and holding company Financial Security Holdings Ltd. (FSA Holdings) on Rating Watch Negative as follows:
FSA
--Insurer Financial Strength (IFS) 'AAA'.
FSA Holdings
--Senior notes 'AA'.
This action reflects developments at Dexia S.A., FSA's parent, which has potential implications for FSA's capitalization and liquidity support, as well as continued challenges to FSA's core franchise. If Fitch were to downgrade FSA, the financial guarantor's rating would be unlikely to fall below 'AA'. Fitch would also consider whether the ratings of FSA Holdings relative to FSA would require a greater differentiation than historically has been the case.
Historically, Dexia has demonstrated a strong financial and strategic commitment to FSA. Its ability to provide additional capital and liquidity support was strengthened following the Dexia's recent recapitalization and explicit sovereign statements guaranteeing Dexia's institutional obligations. That said, the change in ownership and management does create some uncertainty as to Dexia's willingness to provide future support, as well as the nature of that support in terms of its structure and permanence.
Leading up to its recapitalization, Dexia had stated its intention to fully capitalize the credit risk arising from FSA's Financial Products (FP) guaranteed investment contracts (GIC) portfolio, as well as provide a $5 billion dollar unsecured liquidity commitment. More recently, Dexia has decided to cap its commitment to support any future credit losses in the FP's business at $500 million, on an after-tax basis, and stated its intention to convert the $5 billion liquidity line to a secured facility. Both actions are indications, in Fitch's view, of potentially constrained support on the part of Dexia.
While FSA effectively insulated itself from losses in structured finance CDOs, the company is susceptible to weakening U.S. residential mortgage-backed securities (RMBS) sector in both its FP and financial guaranty business lines. For example, assets held in the $18 billion GIC portfolio include $14 billion of RMBS exposures. While mostly originally rated 'AAA' at issuance, Fitch expects losses for these RMBS exposures will materialize. While current capitalization combined with the $500 million of capped commitment from Dexia is sufficient based on loss expectations today, the franchise and FSA's capital resources remain exposed to additional economic stress.
Both the financial guarantor sector and FSA remain mired a challenging environment with uncertain demand for their core product. While FSA was able to insure 62% of municipal wrapped issuance in the first half, their market share dropped off appreciably in the third quarter and overall penetration rates for bond insurance are at historical lows. The prospect of lower ratings from other ratings agencies also has material implications for the franchise and how FSA chooses to manage capitalization, including the possibility that management could decide to manage capital at lower levels in the event of one or more ratings downgrades.
Positively, FSA is exploring alternatives to reduce the potential risk and capital consumption arising from its RMBS and other structured finance exposures. FSA has decided to terminate underwriting of structured finance transactions and run-off the structured finance portfolio, and focus exclusively on originating of municipal and global infrastructure exposures. Fitch also notes the recent strong statements of sovereign support for Dexia and FSA as positive developments.
Fitch will closely follow developments at FSA and Dexia in order to resolve the Rating Watch, including greater clarity with respect to Dexia's capital and liquidity commitments, and any material changes in strategic direction that could impact FSA. While Fitch believes the ratings should not fall below 'AA' based on the current risk profile, the Financial Products GIC portfolio would be subject to substantial collateral calls if FSA's rating fell below the 'AA-' level from either of the other rating agencies, which would lead Fitch to reassess its own credit view.
Financial Security Assurance Holdings Ltd is a U.S. domiciled holding company whose operating subsidiaries, including FSA, provide credit enhancement products to the U.S. and international public finance, structured finance and mortgage markets on a primary basis. For June 30, 2008, FSA reported consolidated GAAP assets of $26.5 billion and shareholders equity of approximately $61.9 million. Fitch notes the equity position negatively affected by Other Comprehensive Income (OCI) write-downs of about $2.1 billion on an after tax basis on the GIC portfolio. FSA's qualified statutory capital is $2.5 billion on June 30, 2008 and on an aggregated basis, net par outstanding totaled $442 billion.
Fitch has placed the following ratings on Rating Watch Negative:
Financial Security Assurance Holdings Ltd.
--$100 million 5.6% senior notes due 2103 'AA';
--$230 million 6.25% senior notes due 2102 'AA';
--$100 million 6.875% senior notes due 2101 'AA';
--$300 million junior subordinated debentures 'AA-'.
Financial Security Assurance Inc.
FSA Insurance Co.
FSA International Ltd. (Bermuda)
FSA (UK)
FSA Seguros Mexico, S.A. de C.V.
--Insurer financial strength (IFS) 'AAA'.
The National Scale rating assigned to the following Mexican subsidiary is unaffected by this rating action:
FSA Seguros Mexico, S.A. de C.V.
--National IFS 'AAA' (mex).
