Exposure to toxic subprime mortgages and collateralised debt obligations of asset-backed securities (ABS CDOs) caused Moody's Investors Service to downgrade Financial Guaranty Insurance Company (FGIC) to Caa3 and then withdraw the ratings.
"The rating agency currently estimates that the expected loss for FGIC's insured portfolio now exceeds claims paying resources," the agency said.
Monolines have tried to mitigate the risk from their exposure to toxic assets. Several have commuted CDO hedges transacted with counterparties in an effort to reduce exposures and free up capital: FGIC entered into an agreement with Havenrock II, a special purpose vehicle created by Dusseldorf-based IKB Deutsche Industriebank, to guarantee up to $1.875 billion of ABS CDOs.
The future for other monolines remains uncertain. Stanislas Rouyer, a senior vice-president at Moody's in New York, said: "Efforts by the monolines to commute some of their ABS CDO exposure under attractive terms, could result in an improved credit profile. However, we can't say that we have a stable view of other insurers because of the uncertainty that remains about the likelihood of such deals and about the performance of insured exposures."
Municipalities that relied on bond insurers for credit enhancement have been punished by the series of bond insurer downgrades due to their exposure to toxic assets. Downgrades led to an exodus of institutional investors from floating-rate financing such as variable-rate demand notes, and to the ultimate collapse of the auction-rate securities market, costing public authorities across the US heavily in restructuring, termination and penalty fees.
"Even with the stronger monolines, we are cautious about the stability of the future demand for financial guarantee products. There has been a lot of discussion at the federal and state levels regarding possible alternatives [for the municipalities]," said Arlene Isaacs-Lowe, a New York-based senior vice-president at Moody's.