Bond Insurer FGIC Gets Fitch Downgrade

Fitch Ratings said it has again dropped the financial strength ratings of FGIC Corp. and its financial guaranty insurance subsidiaries, Financial Guaranty Insurance Company and FGIC UK Ltd., to “CCC” from “BBB.”

The New York-based Fitch, which cut FGIC ratings from “AA” to “BBB” on March 26, said it took the latest action on the bond insurer because FGIC has so far not been able to come up with needed capital and is facing a risk of regulatory intervention.

Standard & Poor's also dropped FGIC to “BBB” in March after the company said it was working on a plan to divide the firm into two separate operations, with municipal bond business in one unit and riskier offerings in another.

At that point, FGIC's principal owner, the PMI Group, had announced that it did not view FGIC as a strategic investment, and would not be contributing capital as part of any recapitalization plan.

Fitch said it has placed FGIC FGIC UK Ltd. on Rating Watch Evolving and FGIC Corp. on Rating Watch Negative.

The rating firm said it expects FGIC will experience further credit deterioration on its book of business, backed by residential mortgage-backed securities.

This deterioration, said Fitch, could lead to further additions in loss reserves, which will increase the possibility that FGIC could become subjected to some form of regulatory intervention.

FGIC, it was noted, as of March 31, would have negative statutory capital if not for the $600 million “contingent gain” the company recognized related to a structured finance collateral debt obligation (SF CDO) transaction, known as Havenrock II, that is being disputed in court.

Fitch said it is monitoring the legal action for implications to the financial condition of FGIC.

If regulators move on the insurer, Fitch said FGIC's exposure to credit derivatives would be subject to immediate termination with its outstanding counterparties. In this scenario, FGIC would be required to settle the CDS contracts at their current market value–a level that Fitch said it believes is considerably greater than the company's existing claims-paying resources.

Given the heightened risk of regulatory intervention, and FGIC's inability to date to raise additional third-party capital, either from its existing owners or externally, it is likely the company will need to pursue the commutation of some of its most capital intensive exposures–namely SF CDOs underwritten in CDS form, Fitch said.

Such options, according to Fitch, are more likely given the precedent set by the recently announced commutation of several SF CDO contracts between Security Capital Assurance Ltd. and Merrill Lynch & Company Inc.

In addition to the court case, Fitch said it expects higher residential mortgage-backed securities loss reserves in the next several quarters.

It noted FGIC's ongoing negotiations with external reinsurance providers that could ultimately improve certain policyholder positions.

If FGIC's financial condition continues to deteriorate and triggers some form of regulatory intervention, regulators will likely prevent FGIC from paying dividends to FGIC Corp. in order to service its debt or other holding company operating expenses, Fitch said.