Fitch said it plans to consult with guarantee insurers before making any broad changes in its model that fell under criticism from one of the carriers it rated.

In a special report titled “Fitch Discusses Financial Guaranty Capital Model and Ratings Methodology,” the New York-based rating service laid out its system for rating guarantee insurers and the logic behind the actions.

Fitch said it developed its system after determining that the risk for United States municipal bond exposures is overstated and the risk of many structured finance bonds is understated.

The key goal of its new capital model (Matrix), introduced in January 2007, “was to address this perceived imbalance found in existing models.”

For certain investor-owned utilities, default rates can be reduced by 50 percent, the report said. The overstatement of municipal business, producing low returns, may have contributed to the “financial guarantee industry's searching for higher returns by growing its structured finance business.”

On the structured finance business side, which includes collateralized debt obligations (CDO) and residential mortgage-backed securities (RMBS), Fitch said it does not rate all of the exposures–less than half–and relies on either Moody's or Standard & Poor's for underlying rating assignments using the lower of the two.

Where guarantors have complained about the use of such ratings, Fitch said it urged the insurer to get an updated rating from Moody's or S&P.

Fitch said it received many compliments on its model, but also complaints that the model was too conservative.

Consequently, it said some guarantors have ceased writing some new business in some of these exposures, validating Fitch's model.

Fitch said that underlying cumulative loss rates from RMBS pools are expected to average 21 percent in 2006 and 26 percent in 2007.

Fitch said it believes its methodology is sound and the guarantee ratings are “generally performing within expectations given the sharp deterioration in subprime risks.”

The report comes just over a week after financial guarantee insurer MBIA requested Fitch to stop rating the company. The insurer's chairman and chief executive officer, Jay Brown, heavily criticized the rating service methodology, saying that it was limited and raises “the risk of misinterpretation.”

A representative from Fitch said in an e-mail that for several years now the rating agency has released draft copies of proposed methodology changes for market feedback and this report did not reflect a change in that policy.

He added that the report's intent is to add to “existing transparency in light of general market questions” on the rating agency's methodology and changes. He said that MBIA's comments have added to those questions.

(This story was updated on March 20 at 9:18 p.m.)