The Financial Security Assurance may put greater emphasis on wrapping loan deals and less on collateralized debt obligations backed by bonds while reducing its exposure to the investment-grade cash flow market. The new criteria for writing insurance protection on CDOs is expected to be announced in a couple of weeks, after the FSA's underwriting committee meets during a board meeting, says a person familiar with the situation. FSA's redefined role in the CDO insurance market is important for underwriters and collateral managers because downgrades have boosted investor demand for wraps while the number of insurers playing an active role on the CDO market is shrinking.
The FSA's move to wrap loan deals would mean less emphasis on CDOs backed by bonds, says one person familiar with the situation. Reducing its coverage of the investment-grade funded sector would be because, "synthetic execution is pretty compelling" for this type of collateral, which has led credit default swaps to become the primary method of structuring investment-grade CDOs, he says.
William Fischer, managing director of structured finance at FSA, says that, "Even though I can't predict the outcome of [our internal review], I think it's well recognized in the market that collateralized loan obligations have outperformed CBOs over the past five years and that it looks to be the direction of the market." He declined to comment on the date and agenda of the board meeting. But, he says that, "We are still in the process of evaluating our credit criteria for CDOs in general, which most likely will result in changes in our underwriting requirement," adding that, "We hope to complete this internal process in the near future."
The revised emphasis by the FSA is timely given that Ambac Assurance Corp. and MBIA, FSA's primary competition, recently announced that they are pulling out of a portion of the synthetic CDO market. If, as some speculate, FSA decides to insure CDOs more selectively, it could raise the cost of premiums investors pay to have bonds insured.
A top CDO official at a dealer says Dexia, the European bank that owns FSA, pushed FSA to scale back participation in the CDO market last summer due to Dexia's concerns about poor performance of some of the collateralized bond obligations wrapped by FSA. Betsy Castenir, a spokeswoman at FSA, declined to comment on Dexia's alleged participation in FSA's efforts to reshape its CDO insurance guidelines. But, she concedes that FSA has insured seven high-yield funded collateralized bond obligations issued in 1998 and 1999 that have an estimated loss of $51.5 million. She declined to name the deals, and plays down the importance of these potential losses by stressing that, "If claims should result, they would not come due for six to 10 years." Philippe Ducos, Dexia's head of capital markets in Paris, declined to comment.