Despite the problems besetting its fellow bond insurers, Financial Security Assurance (FSA), the third largest financial guarantor, has been riding high.
Wholly owned by Franco-Belgian bank Dexia, FSA has been able to keep its AAA' ratings from Fitch Ratings, Moody's Investors Service and Standard & Poor's, and has seen its market share surge in the past two months.
In 2007, FSA was the top municipal bond insurer, with a 24.3% market share. In December, it captured a 52% market share, which rose to 70% in January. The guarantor insured 1,690 issues for a total of $46.2 billion in 2007, compared to Ambac, which followed with 1,079 insured deals worth $45.5 billion, and MBIA, which insured 1.029 worth $44.3 billion, according to Thomson Financial.
So what did FSA do differently?
The main reason FSA was able to avoid massive damage is that it has been selective in the subprime mortgage market and avoided CDOs of ABS and CDOs-squared (CDOs of CDOs).
"In the CDOs of ABS and CDOs-squared area, we didn't believe the CDO securitization technology could be applied, because the underlying assets were basically not individually analyzable and therefore an accurate correlation could not be ascertained," said Sean McCarthy, FSA's president and COO.
McCarthy said the company has long been concerned about the lack of credit discipline in the market.
"In our view, structures and pricing were increasingly aggressive, while asset quality was deteriorating," McCarthy said. "In other sectors, we concluded that asset performance was either too unpredictable or too volatile, or both, to support our participation at any level of compensation. In general, we felt that asset performance was being too optimistically viewed by many market participants."
About 66% ($282.7 billion) of FSA's insured transactions as of Dec. 31, were public finance and 34% ($143.8 billion), were ABS. Of the total, 99% are rated investment grade, with 26% being AAA' rated, 32% rated AA' rated, 30% A rated and 11% BBB' rated.
Dirk Peeters, an analyst who covers Dexia for KBC Securities in Belgium, said FSA is harvesting the fruits of a conservative policy, having avoided CDOs squared and CDOs of ABS.
"If you are wrapping existing wrapped bonds you can't monitor underlying assets, you can't monitor risk," Peeters said. "The other monolines didn't anticipate what could go wrong; they did it to generate more business. That's what happened with MBIA and Ambac, that's why they have such big losses. Those instruments are like Christmas presents wrapped in paper, then rewrapped in another paper. Unfortunately, they didn't get any Christmas presents."
In a letter to investors dated Oct. 31, 2007, Robert Cochran, FSA's chairman and CEO, says that looking back, staying the course in the liquidity-rich and credit-insensitive markets of the past few years had been difficult.
"We were often crowded out of areas where we had traditionally been perceived to add value. Our restraint has now paid off," he said in the letter. He believes, however, that what's happened over the last year is not a failure of the monoline business model but the result of a single mistake in one asset class.
Fitch Managing Director Thomas Abruzzo said the reason FSA was able to keep a AAA' rating is because it maintained a strong capital base, and more importantly, took a firm and disciplined approach not to insure CDOs of ABS.
Asked why the other monolines didn't follow the same approach, Abruzzo said it's possible they didn't understand the complexity of the transactions. He also noted that, depending on how the deals are analyzed and stress tested, conclusions could simply differ.
"At this point in the market, and given the pressure of others monolines, FSA is in a sweet spot now," Abruzzo said. "They will pick and chose deals in the market and get very good premiums. Will this last forever? Probably not. But right now, there still is a need for bond insurers and FSA is at the top. A lot of people want to do business with them and are wiling to pay for it."
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