Fitch Affirms FSA's 'AAA' IFS, 'AA' Senior Debt Rating

Business Wire, June 6, 2005

NEW YORK -- Fitch Ratings-NY-June 6, 2005: Fitch Ratings affirms the 'AAA' insurer financial strength (IFS) rating of Financial Security Assurance Inc. (FSA) and the 'AA' senior debt rating of Financial Security Assurance Holdings Ltd. (FSA Holdings). FSA Holdings, the parent company of FSA, is a subsidiary of Dexia S.A. (Dexia), a Belgian financial institution with a long-term rating of 'AA ' and an individual bank rating of 'A/B'. The Rating Outlook for all entities is Stable.

FSA's IFS rating reflects the high quality of the company's insured portfolio, solid market position in the financial guaranty industry, conservative underwriting standards, a predictable earnings stream, ownership by Dexia, and effective risk management procedures. Concerns center on a more highly leveraged capital base and higher single risk concentrations relative to that of its peers, potential competitive pressure from new market entrants, greater exposure to reinsurers, and some remaining troubled exposures within its existing legacy portfolio.

FSA maintains a solid market position in the financial guaranty industry, where it ranks as the third-largest guarantor based on March 31, 2005 net par outstanding of $332.7 billion. In addition, Fitch believes that the quality of the in force portfolio is quite strong. Just 0.6% of FSA's net in force par is below investment grade as of March 31, 2005, which compares favorably to an average of about 1.1% for the four largest financial guarantors. Although the insured portfolio is generally well diversified, there is some concentration to the collateralized debt obligation (CDO) and residential mortgage-backed securities areas; however, this concern is mitigated by the high percentage of transactions with attachment points at or above 'AAA' in these sectors. As a result, 25.8% of FSA's net par in force is rated 'AAA' compared with an average of about 15% for the four largest guarantors.

Fitch notes, however, that if competition or spread compression were to cause FSA to reduce its emphasis on 'AAA' rated transactions for a prolonged period of time, its high percentage of in force par in the strongest rating categories could become more aligned with industry averages, as the majority of these 'AAA' transactions tend to be of relatively modest duration. Fitch also notes that FSA has begun insuring mezzanine layers of synthetic CDOs at or above 'AAA' attachment points. A mezzanine layer of a securitization is more susceptible to greater loss severity in the event of default, given that it is subordinate to the 'excess layer.' However in FSA's case, this risk is mitigated by the significant credit enhancement underlying each transaction because FSA only insures such transactions at levels materially above the 'AAA' attachment point. Moreover, FSA typically insures a sizable percentage of the 'AAA' tranche, thereby offsetting some of the effect of the subordination.

In 2004, FSA Holdings reported consolidated net operating income of $326.1 million and operating return on equity of 14.9%, which is at the high end of the financial guaranty industry range. FSA's emphasis on highly rated and capital-efficient transactions has enabled it to achieve attractive risk-adjusted returns despite the increasingly competitive business environment.

As of March 31, 2005, FSA had net par leverage (net par in force/total statutory capital) of 143:1, which is high relative to industry averages. Related to this, FSA's largest single risks represent a substantially higher percentage of capital than its competitors, as the company must in many cases compete against more heavily capitalized rivals, MBIA Insurance Corp. and Ambac Assurance Corp., for the same pool of profitable larger deals. These risks are moderated by the high quality of FSA's insured portfolio.

FSA cedes about 26% of its gross par insured to various reinsurance companies, which is high relative to its industry peers. FSA also enhances the underlying credit ratings of some of its higher risk insured transactions through the use of layered-loss reinsurance; whereby a disproportionate share of a transaction's first-loss exposure is ceded to highly rated reinsurance companies. While helping to shape the portfolio and enhance its overall quality, FSA's reliance on reinsurance leaves it more susceptible to the downgrade risk of its reinsurers compared with its major competitors. FSA mitigates this risk with reinsurance treaties that permit it to increase ceding commissions or take back exposure in the event of a reinsurer downgrade and by having collateral arrangements with some of its reinsurers.

Fitch believes that an improving economy has helped provide stability to legacy transactions, primarily CDOs, which had deteriorated in prior years. Additionally, greater stability in the marketplace has afforded FSA opportunities to remediate some of the weakest insured obligations and reduce potential future claims associated with these obligations.

As of Dec. 31, 2004, FSA Holdings had $17.1 billion in consolidated assets, $430 million of long-term debt, and $2.5 billion in stockholders' equity. Financial leverage was 14.4%, which is within established guidelines Fitch has maintained for financial guarantors. FSA Holdings is a subsidiary of Dexia, the largest public finance lender in Europe with total assets and equity of $531 billion and $14.3 billion, respectively, as of Dec. 31, 2004. Fitch believes that the Dexia relationship will foster growth at FSA over time, particularly in the European public finance market.