Moody’s Investors Service warned Tuesday that four out of five financial guarantee companies it covers that insure collateralized debt obligations (CDOs) have indirect exposure to subprime mortgage loans that could affect their ratings.
Moody’s said that five companies it provides insurer strength financial (ISF) ratings for insured $61 billion in CDOs in 2006 and 2007. The CDOs’ investments include mortgage-backed securities (MBS) and asset-backed securities (ABS).
If cumulative losses on mortgage-backed securities backed by subprime loans hit 14 percent, four of those companies — Ambac Financial Group, Financial Guaranty Insurance Co., Security Capital Assurance and CIFG — could face material losses that could lead Moody’s to lower their Aaa insurer financial strength (IFS) ratings, analysts said.
“AMBAC, FGIC, SCA and CIFG would all need to undertake capital strengthening measures to maintain their Aaa ratings,” Moody’s said in a press release announcing the report.
A fifth financial guarantee company covered by Moody’s — MBIA Inc. — that insures ABS CDOs would remain “adequately capitalized” to handle potential claims and keep its Aaa IFS rating, the report said.
Moody’s said three other financial guarantee companies — Financial Security Assurance, Assured Guaranty Corp. and Radian Asset Assurance — have not insured meaningful volumes of ABS CDOs in recent years.
Because of the difficulty in evaluating the exposure of ABS CDOs to subprime loans, the report is likely to be disputed.
The insured ABS CDOs have invested in subprime MBS or other CDOs that have invested in securities that include some subprime MBS, Moody’s analysts said.
“The complexity of these exposures, with the subprime mortgage loan risk being once or twice removed from the direct investment of the ABS CDO, renders reasonable estimation of CDO performance … quite challenging,” the report acknowledged.
The models used by Moody’s are sensitive to the collateral type and rating distribution of CDOs within other CDOs, the report said. In reviewing the particulars of selected deals, Moody’s analysts said their assumptions “appear to be conservative,” but that they will continue to refine their models.
Companies rated by Moody’s also insured $7.5 billion in MBS backed by subprime loans in 2006, but those guarantees are not expected to result in significant claims, the report said.
Moody’s expects cumulative losses for the worst-performing pools of subprime loans originated in 2006 to range from 10 to 16 percent. But the Aaa ratings on most of the insured MBS protects insurers from claims unless losses reach 26 to 30 percent, the report said.
