Financial Guarantors. Special Comment

Transcription

1 Special Comment Moody s Global December 2007 Table of Contents: Introduction 1 Analysis of Mortgage Risk and Impact on Current Ratings 2 Stress-Test Outcomes 2 Rating Actions 3 Business Conditions and Next Steps 3 Rating Profile: Analysis and Rating Actions in a Period of Volatility Teleconference prepared remarks of December 17, 2007 Introduction By Ted Collins, Group Managing Director Global Insurance Welcome to Moody s presentation on the financial guarantors. My colleagues Jack Dorer, Managing Director of Moody s Financial Guarantor team, Stan Rouyer, a Senior Vice President covering financial guarantors, and I will provide an overview of Moody s recent rating actions in the financial guarantor sector. Analyst Contacts: New York Ted Collins Group Managing Director Global Insurance 0 Jack Dorer Managing Director Stan Rouyer Senior Vice President Let me review our analytical steps briefly. On September 25th, Moody s published a report discussing our analysis of financial guaranty insurers exposure to the subprime RMBS market, highlighting ABS CDOs as a source of potential strain on capitalization, and indicating that we would further refine our analysis. On November 8th, we updated the status of our analysis and outlined how we were assessing the impact of continuing RMBS market deterioration on the financial guarantors ratings. On December 5th, we provided additional updated detail about the analytic methods, processes, and timing of our assessment. On December 14, Moody s announced the results of the assessment: there were ratings affirmations of six financial guaranty insurers and two reviews for downgrade. The Aaa ratings of Ambac, Assured Guaranty, and FSA were affirmed with stable outlooks, as was the Aa3 rating of Radian Asset Assurance. The Aaa ratings of MBIA and CIFG were affirmed, but with their outlooks changed to negative from stable. The Aaa ratings of FGIC and XL Capital Assurance, however, were placed on review for possible downgrade.

2 These actions resulted from our reassessment of the financial guaranty insurers capital adequacy in light of their exposure to the difficult US residential mortgage market, with consideration also given to their capital management plans and ongoing strategies. Stan Rouyer will describe details of the analysis Moody s has been conducting on the mortgage exposures of financial guarantors, as well as the results. Jack Dorer will then offer some closing thoughts about the current state of the financial guaranty business and outline the next steps in our analytic process. Analysis of Mortgage Risk and Impact on Current Ratings By Stan Rouyer, Senior Vice President By way of background, I want to describe how financial guarantors have assumed their current level of mortgage-related exposure. They have done this in two primary ways: first, through their direct insurance of residential mortgage-backed securities (RMBS); and secondly, by insuring structured instruments that have been collateralized by asset-backed securities (or ABS CDOs) containing mortgage exposure. The unprecedented level of stress in the US mortgage markets, together with the sizable exposures that some of the guarantors have accumulated over the past couple of years, prompted us to undertake specific analysis of this segment of the financial guarantors portfolios. Generalized stress in credit markets could ultimately affect other insured exposures, but we believe that most other sectors of the insured market have remained fairly resilient. We have evaluated the impact of mortgage market stress on guarantors capital adequacy using two distinct approaches. We refer to the first as the base case ; in this, we use Moody s traditional financial guaranty portfolio model, which is a transaction-by-transaction stochastic stress model. This is driven by estimates of probability of loss and loss-given-default for each exposure. These underlying risk estimates for RMBS and ABS CDOs reflected Moody s recent rating actions in those areas. In some cases (for example, where ratings are under review or are in sectors expected to be reviewed), the estimates were based on our judgments of potential ratings migration. The second approach, which we refer to as the stress case, uses a different simulation model to estimate ABS CDO losses under a more severe strain, employing more granular information about underlying collateral. Our stress case is intended to approximate an environment where 2006-vintage subprime first-lien mortgages would experience, on average, cumulative losses of 19% (as compared with our current estimate of about 11%). For other RMBS collateral types and vintages within ABS CDOs, we scaled up or scaled down, according to their anticipated performance relative to 2006 subprime RMBS. For example, we scaled up for 2007 vintage subprime and for closed-end second liens, and we scaled down for 2005 vintage and for Alt-A loans. Stress-Test Outcomes The results of our base-case model were measured against the target capital ratio, which is 1.3x the minimum capital ratio appropriate for the rating. The results of our stress-case model were compared to the minimum capital ratio for the rating, which is equal to 1.0x losses at the tail of the distribution. Some financial guarantors fell below Moody s capital-adequacy benchmarks for their rating categories, either under the base-case or stress-case method. In those cases, we communicated to the managements concerned our views about the key sources of deterioration, as well as a rough estimate of the shortfall relative to the current rating level. We also engaged in discussions about the range of actions they were actively considering to strengthen their capital positions. Some components of these plans have been announced publicly, and others have not. To the extent that firms have not publicly disclosed specific elements of their plans, we believe that it would not be appropriate for us to comment on them. 2 December 2007 Special Comment -

3 Another factor in our analysis: whether or not the guarantor s capital-strengthening plan would ultimately result in the company exceeding the relevant capital adequacy benchmarks -- and over what period? Here, we considered several variables, including the specific components of the plan, the potential sources of support, and the likely motivations and commitment of support providers. Rating Actions In cases where the estimated capitalization levels exceeded Moody s benchmarks for the company s rating, we affirmed the rating with a stable outlook. This was true for Ambac, Assured Guaranty, FSA, and Radian Asset. Where estimated capitalization levels fell below Moody s benchmarks for the company s rating, we initiated reviews for possible downgrade (that is, for FGIC and XL Capital Assurance) -- except where we believed there to be significant progress toward implementing a remediation plan. In such cases we changed the outlook to negative -- the outcome for CIFG and MBIA, which have both publicly announced capital-raising plans. Business Conditions and Next Steps By Jack Dorer, Managing Director I d like to address the topic of disclosing capital shortfall amounts. At this time, we are not prepared to make public an estimate of any guarantor s capital shortfall amount. We believe that this is not constructive, and such estimates could even be misleading, for a number of reasons: First, we believe that disclosure of a specific shortfall amount inevitably tends to focus attention too narrowly around solving for a number, instead of focusing around the broader assessment of strategic capital management that may be required. Second, there is judgment involved in assessing the relative impact on capital, or risk of effecting different types of capital solutions. Not every type of transaction envisioned will result in money in the bank up front. Third, neither capital nor risk is static. Both are likely to change and those changes could be material -- in either direction -- over the period in which capital plans are refined and executed. I d like to close with some broader comments about the business of financial guaranty, given the intense stresses currently affecting credit markets, and talk about next steps in Moody s analytic process. Mortgage-related risks of some financial guarantors have clearly pressured their capitalization levels, and further deterioration obviously could result in additional capital needs. What is less clear is how this experience might ultimately affect the strategies pursued by firms in this business. From one perspective, recent dramatic shifts in the market s perception of credit risk ought to play into the hands of financial guarantors, as the risk premium for credit increases. However, reduced issuance volumes generally, and investor caution about financial guarantors specifically, have both limited the ability of at least some financial guaranty insurers to take full advantage of the market s credit-risk re-pricing. It is uncertain how long this situation will persist. Also, how recent disruption in credit markets might alter the demand function for financial guaranty insurance in the future is not yet apparent. Moody s will continue to evaluate these issues, and their effects on ratings for financial guarantors, as information develops. In the near term, we will be seeking specifics about the guarantors capital plans and assessing their progress toward execution. There are, broadly speaking, two levers that guarantors can pull to improve their capitalization. They can increase their capital by raising funds from existing or new investors, and/or they can reduce their risk through portfolio amortization, reinsurance, or other risk transfer mechanisms. Based on our discussions with guarantors, we believe that capital enhancement efforts may well involve multiple components. 3 December 2007 Special Comment -

4 We expect to conclude the rating reviews of FGIC and XL Capital Assurance after their capital remediation plans have been executed, which we recognize could take some months. We would expect to resolve those reviews sooner, with downgrades, if -- based on our further assessment of the plans components -- we concluded that the companies anticipated capitalization levels, in the context of their respective risk profiles and business strategies, would be inconsistent with the Aaa rating level -- even if the plans were to be executed. In the case of MBIA, we will also continue to evaluate its capital plans and tracking toward execution. We would expect to revisit our negative outlook after their capital remediation plans have been executed. As for CIFG, we will monitor the execution of its announced capital plans, and we will engage its new shareholders in further discussions about the strategic focus and direction for the firm. *** That concludes our prepared remarks. We thank all of you for your time and interest. If you have additional questions, please them to A replay of this discussion may be accessed via the Events page on Moodys.com. 4 December 2007 Special Comment -

5 Author(s) Ted Collin ProductionManager William L. Thompson Copyright 2007, Moody s Investors Service, Inc. and/or its licensors and affiliates including Moody s Assurance Company, Inc. (together, MOODY S ). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided as is without warranty of any kind and MOODY S, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. Under no circumstances shall MOODY S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings and financial reporting analysis observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling. MOODY S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY S have, prior to assignment of any rating, agreed to pay to MOODY S for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,400,000. Moody s Corporation (MCO) and its wholly-owned credit rating agency subsidiary, Moody s Investors Service (MIS), also maintain policies and procedures to address the independence of MIS s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually on Moody s website at under the heading Shareholder Relations Corporate Governance Director and Shareholder Affiliation Policy. 5 December 2007 Special Comment -