Moody's Investors Service yesterday downgraded CIFG Assurance NA to junk status, moving the financial guarantor's insurer financial strength rating to Ba2 from A1.

Moody's said the company's conservative valuations of its collateralized debt obligations could force it to reserve more capital against losses and that might set off a cascade of events leading to insolvency.

"The rating actions reflect the high likelihood that, absent material developments, the firm will fail minimum regulatory capital requirements," Moody's said.

The ratings remain under review with no direction, owing to the uncertain nature of CIFG's efforts to raise additional capital or find other solutions, according to the rating agency.

If the bond insurer does fall short of regulatory capital requirements in both New York and Bermuda, where it is based, it could set off a chain of events that could leave it insolvent, Moody's said.

The downgrade appeared to come as something of a surprise to the bond insurer, which has been trying to come up with solutions to its current problems. Late last year, the two French banks that own CIFG - Banque Populaire Group and Caisse d'Epargne Group - contributed $1.5 billion in capital to the bond insurer, but since then they have not provided further support.

"While we are very disappointed by this action, we continue to work aggressively to protect our policyholders," said John Pizzarelli, CIFG's chief executive officer, in a prepared statement. "We are currently in negotiations to develop strategic alternatives for problematic credits with the goal of CIFG emerging with a clean balance sheet and significantly improved capital position."

The problem lies in the way that CIFG evaluates the values of the CDOs in its portfolio, Moody's said. According to the rating agency, CIFG uses a conservative approach that looks at the lowest rating on the CDOs among the three rating agencies.

As all three rating agencies have downgraded residential mortgage-backed securities since the beginning of the year, CIFG may soon need to increase its capital loss reserves to cover additional declines in value. As one of the newer bond insurers to enter the market, the CDO exposure that CIFG has is concentrated in the worst-performing years, from 2005 to 2007.

Setting aside additional loss reserves could cause CIFG to breach regulatory capital requirements in the near future, the rating agency said.

A spokesman for the New York State Insurance Department said the bond insurer had not breached the statutory capital threshold, but that if it did it would be considered insolvent. In the event that this happens, the department would likely ask the bond insurer for a plan before taking over the company or taking further action.

Moody's concern also relates to the credit default swaps that CIFG uses to guarantee CDOs. These contracts have provisions embedded in them that could be terminated if the bond insurer is declared insolvent, Moody's said.

While the firm has not yet breached the capital threshold or been declared insolvent, further action from regulators or exposure to other risks could constitute insolvency for the purposes of the CDS, Moody's said. In the event that the termination provisions are triggered, CIFG does not have enough claims-paying resources to pay those obligations, Moody's said.

Moody's also cited the fact that CIFG has not met deadlines for regulatory filings, including first quarter 2008 results for CIFG Assurance NA and year-end 2007 results for CIFG Guaranty.


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