NEW YORK (Reuters) - Bond insurer FGIC Corp said on Wednesday that its exposure to mortgage losses exceeded legal risk limits and it may adjust its loss reserves due to litigation related to stricken German bank IKB.
FGIC, the parent of bond insurer Financial Guaranty Insurance Co, earlier this month sued German state-owned IKB IKBG.DE on fraud charges of providing incomplete information on $1.9 billion of debt that FGIC agreed to insure.
FGIC in a statement also said it has a substantially reduced capital and surplus position through December 31. As a result, insured exposures exceeded risk limits required by New York state insurance law, the New York-based company said.
"This is a bombshell," said Rob Haines, senior insurance analyst at CreditSights in New York. "They are actually in violation of New York insurance law. If they don't remediate this, the state has the ability to take control of the company."
Haines estimated that FGIC would need to raise about $2 billion to stabilize the company.
A FGIC spokesman characterized the issue as a "technical violation."
New York Insurance Superintendent Eric Dinallo's office said they were reviewing the new information.
"We're carefully monitoring all the bond insurers, including FGIC," said David Neustadt, a spokesman for the insurance department. FGIC has reassured the state that it will file a business plan "very soon," he said.
The consequence of violating the regulation is a requirement to file a plan. If the plan is not adequate, the consequence is that they can write no new business, Neustadt said.
FGIC in notes to its consolidated financial statements said it plans to submit a plan to Dinallo to reduce its risk. FGIC also said it has voluntarily ceased writing new business to preserve capital.
"Management is assessing whether the loss reserve related to the commitment agreement needs to be adjusted in the future to reflect the impact of these developments," FGIC said in a statement. "Any such adjustment could be material."
Bond insurers have been facing increasing pressure on their ratings as some companies expanded into insuring complex debt tied to deteriorating U.S. mortgages.
The bond insurers were not alone in overreaching. Once a little-known lender, IKB took center stage last year as Germany's first subprime casualty when its investments in the market for the risky U.S. mortgages soured.
The affair has become an embarrassment for Germany as a banking center. The government has stepped in to try to save IKB from collapse.
The bank is due to hold its annual general meeting on Thursday in Duesseldorf.
SCA CUT TO JUNK
All three of the main credit rating companies recently cut FGIC's ratings, limiting its ability to insure bonds and generate new business.
Fitch Ratings on Wednesday said it cut its ratings on FGIC Corp and its insurance units due to the company's capital position. FGIC Corp's long-term issuer rating was cut to "BB," or two levels below investment grade, from "A," or the sixth highest investment grade.
Fitch also on Wednesday cut its ratings on Security Capital Assurance SCA.N, parent of bond insurer XL Capital Assurance, to junk bond status, citing its exposure to U.S. subprime mortgages.
Fitch said SCA's current level of capital and claims paying resources are no longer consistent with Fitch guidelines for an investment grade rating.
Standard & Poor's said on March 21 that it might downgrade FGIC and its insurance arm due to a decision by the bond insurer's principal owner, PMI Group PMI.N, not to put more capital into FGIC.
Other owners of FGIC include private equity giant Blackstone Group (BX.N), which was part of a consortium that bought FGIC from a General Electric Corp (GE.N) unit in 2003.
PMI shares fell 8.2 percent to $6.38 on Wednesday. Blackstone shares were down 0.7 percent to $16.16.
S&P had stripped FGIC's insurance arm of its top "AAA" rating in January and now rates the company "A," the sixth-highest rating. It rates FGIC Corp "BBB," the second-lowest investment grade.
Unlisted FGIC posted a fourth-quarter loss of $1.89 billion from its exposure to collateralized debt obligations related to asset-backed securities.
(Editing by Leslie Adler)