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

Business Wire, Sept 18, 2006

NEW YORK -- 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 its solid market position in the financial guaranty industry, the high quality of the company's insured portfolio, conservative underwriting standards, an historically strong earnings stream, ownership by Dexia, and effective risk management procedures. Concerns center on a competitive industry environment and, relative to its key competitors, a more highly leveraged capital base, higher levels of single risk relative to its capital base and greater exposure to reinsurers.

FSA maintains a solid market position in the financial guaranty industry, where it ranks as the third-largest guarantor based on June 30, 2006 net par outstanding of $361.8 billion. Fitch believes that the quality of FSA's in force portfolio is quite strong. As of June 30, 2006, approximately 55% of FSA's net par in force is rated 'AA-' or higher compared to 41% for its two most established competitors. Although the insured portfolio is generally well diversified, there is some concentration to the collateralized debt obligation (CDO) and pooled credit default swaps (CDS); however, this concern is mitigated by the high percentage of transactions with attachment points at or above 'AAA' in these sectors. Fitch notes within the company's CDS portfolio, FSA continues to insure mezzanine layers of risk protection, albeit at very high (at or above 'AAA') attachment points. FSA has engaged in these transactions to reduce its exposure to large single risks, as individual pooled CDS transaction have become extremely large in the past few years, and to respond to market demand.

In prior years, FSA's returns have generally been quite strong relative to the industry average; however, more recently, returns have experienced some pressure. This result is not surprising to Fitch due to spread compression, industry competition from less established entrants and increased investor acceptance of senior-subordinate securitization structures. In response to slower growth prospects, beginning in the fourth quarter of 2005, FSA Holdings has significantly increased the level of dividends it pays to its owner Dexia, a strategy that is similar in ultimate impact to the stock repurchases of its two established competitors. Since most of the parent company's operations are conducted through FSA, the long-term ability of FSA Holdings to service its debt and fund dividend payments to its owner will largely depend upon the receipt of dividends or surplus note payments from FSA. Fitch believes that FSA has the ability to fund at least the projected level of dividend payments to Dexia without adversely affecting its IFS rating, particularly as Fitch presently would expect slower growth in par written to slow growth in the insurer's required capital levels over at least the intermediate term.

For the past several years, FSA's strategy has been to focus on originating highly rated and capital efficient transactions, resulting in a more leveraged capital base than its two established competitors. As of June 30, 2006, FSA had net par leverage (net par in force/total statutory capital) of 144:1, which is high relative to industry averages. Additionally, for comparative analytical purposes, Fitch adjusts net par leverage to include FSA's $17.6 billion of par exposure senior to its mezzanine exposure; recalculated on this basis, the adjusted net par leverage of FSA is 151:1. Although FSA is not obligated to pay losses on par exposure above their insured tranches, their level of recoveries could be directly affected in the remote instance that losses are incurred because of the subordination of their tranche to the more senior exposure. Related to its higher leverage levels, FSA's largest single risks represent a substantially greater percentage of capital than its competitors. Fitch believes that risks associated with FSA's leverage, mezzanine exposures and large single risks are mitigated 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 counterparty 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.