Fitch Details Approach to Assessing Financial Guarantors' SF CDO Exposures

NEW YORK & LONDON--(BUSINESS WIRE)--Fitch Ratings announced today the process it will employ in updating its analysis of the structured finance collateralized debt obligations (SF CDOs) insured by the financial guaranty industry, as well as the potential implications for their 'AAA' Insurer Financial Strength (IFS) ratings. The updated analysis announced today is an extension of an analysis completed by Fitch on Sept. 6, 2007 published in a special report entitled 'Financial Guarantors - Matrix Hypothetical Subprime Stress Test Results'. In this earlier report, Fitch discussed its 'stress test' analysis of the capital adequacy ratios of the financial guarantors based on potential credit deterioration in insured transactions with exposure to the subprime mortgage markets.

Fitch is updating its capital adequacy analysis due to the nature of recent ratings actions taken by Fitch, Standard & Poor's, a Division of the McGraw-Hill Companies, Inc. and Moody's Investor Services, with respect to SF CDOs exposed to subprime residential mortgage backed securities (RMBS). Generally, the extent of both downgrades and placements of securities on Rating Watch Negative is broader and deeper than the assumptions used in Fitch's Sept. 6 analysis.

Fitch's analysis will focus on the nature of the SF CDOs held by each financial guarantor, with a goal of determining the likely ratings migration within each financial guarantors' SF CDO portfolio. Lower ratings on insured transactions will result in higher capital requirements in Fitch's 'Matrix' capital model, since simulated default rates increase when moving down the ratings scale. Fitch notes that capital requirements in Matrix become especially pronounced for SF CDOs that are rated BBB and lower, and it is expected that the ratings on some SF CDOs will migrate to these levels. Fitch will also apply additional stresses to simulated recovery rates to SF CDOs as part of its capital adequacy analysis, which will increase simulated loss given default rates for this asset class.

As Fitch assesses the SF CDO portfolios of each financial guarantor, differentiation will be made based on the relative exposure to 'mezzanine' and CDO-squared securities, as opposed to 'high grade' CDOs. Fitch will also focus on the attachment points on the insured securities.

'Mezzanine' CDOs in this context are defined as those CDOs for which the ratings on underlying collateral are rated 'BBB' and lower. It is these 'mezzanine' CDO securities for which ratings migration risk is generally the greatest, and loss severity in the event of default may be most pronounced. Fitch's analysis of attachment points recognizes that a vast majority of financial guarantor insured SF CDOs were originally rated 'AAA', but that in many cases the securities attached a levels well above minimum 'AAA' thresholds (or so-called 'super-senior' attachments). Generally, the greater the attachment point in excess of a minimum 'AAA' standard, the more muted is the risk of material ratings migration, or increased loss severity.

A possible conclusion of Fitch's analysis will be that one or more of the financial guarantors may no longer meet Fitch's 'AAA' capital guidelines. At the conclusion of its analysis, Fitch would expect to place on Rating Watch Negative the IFS rating of any financial guarantor whose capital ratio falls below Fitch's 'AAA' benchmark, as at that point uncertainty would reach a materiality that would call into question the company's ability to maintain its rating. Fitch would then expect to provide the company approximately one month to either raise capital, or execute a risk mitigation strategy, that would allow it to again meet Fitch's 'AAA' capital standards. Failure to do so would result in a downgrade of the IFS rating.

Fitch notes that should a financial guarantor add to its capital, or enact an effective risk mitigation strategy prior to the completion of its capital analysis, Fitch would consider the impact of such activities in formulating the conclusions from its capital analysis. Fitch expects to complete its capital analysis within the next four-to-six weeks.

The following are preliminary observations on the positioning of the 'AAA' rated financial guarantors, and the relative probability that each may experience erosion of their capital cushions under Fitch's updated stress analysis. These observations are based on Fitch's Sept. 6 study, preliminary review of each guarantor's performance on Matrix as of June 30, 2007 and, where available, Sept. 30, 2007, and analysis to date of the risk profile of each guarantor's SF CDO portfolios:

--High Probability: CIFG Guaranty (CIFG) and Financial Guaranty Insurance Company (FGIC) appear most likely to experience contraction in their capital cushions under Fitch's analysis, barring additional capital raising or risk mitigation efforts. This reflects the materiality of SF CDO exposures relative to the most recently measured capital cushion. Fitch notes FGIC appears to be the better positioned of the two due to more recent improvements to its existing capital cushion;

--Moderate Probability: Ambac Assurance Corp. (Ambac) and Security Capital Assurance (SCA) may also experience pressure in their capital cushions due to relatively high SF CDO exposures relative to the most recently measured capital cushion. However, the degree of cushion relative to exposures is better than for the companies noted above. Fitch's assessment of SCA includes the impact of certain recent risk mitigation initiatives;

--Low Probability: MBIA Insurance Corp. (MBIA) appears to be materially better positioned than the four previously noted guarantors due a lower level of higher-risk SF CDOs relative to the most recently measured capital cushion. Fitch notes MBIA underwrote SF CDOs in third quarter 2007, and will consider these recently added exposures in its analysis;

--Minimal Probability: Due to minimal SF CDO exposures and strong initial capital cushions, Fitch anticipates no capital or rating issues resulting from its updated capital reviews of Assured Guaranty Ltd. (Assured) and Financial Security Assurance Inc. (FSA).

Fitch recognizes that financial guarantors view maintenance of their 'AAA' ratings as a core part of their business strategies, and management teams will take any reasonable actions to avoid a downgrade. However, Fitch also recognizes that recent capital markets volatility, including sharp declines in the share prices of the publicly traded financial guarantors, may make capital raising efforts difficult unless market conditions improve.

Fitch has previously stated that losses reported during the third quarter of 2007 by a number of financial guarantors due to mark to market accounting standards for insurance sold in credit derivative form are not a ratings concern (see Fitch's Oct. 11 special report 'Financial Guarantors - A Review of Recent Mark to Market Losses'). Similarly, Fitch's capital adequacy analysis discussed here today will focus on underlying fundamental credit performance of insured portfolios, and will not be based on market value movements of insured securities.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.