Fitch cuts FGIC to junk on regulatory takeover fear

NEW YORK, July 31 (Reuters) - Fitch Ratings on Thursday slashed Financial Guaranty Insurance Co's rating deep into junk territory, citing an increased likelihood of regulatory intervention due to mounting expected losses on mortgage-backed debt.

Fitch cut FGIC's insurer financial strength rating nine notches to the speculative rating of "CCC" from "BBB," the second-lowest investment grade level. Fitch continues to review the rating.

The action is based on expectations that FGIC will experience further credit deterioration on its book of business backed by residential mortgage-backed securities, the rating agency said in a release.

"This deterioration could lead to further additions in loss reserves which will increase the possibility that FGIC could become subject to some form of regulatory intervention," Fitch said.

The industry regulator, the New York State Insurance Department, requires bond insurers to maintain a minimum surplus capital of $65 million.

FGIC would have already had negative statutory capital at the end of the first quarter, if not for a $600 million "contingent gain" related to a disputed structured finance transaction that the company recognized in its income statement, the rating agency said.

If the bond insurer were taken over by the regulator, it would need to terminate its credit derivative contracts at the current market value, which Fitch believes is "considerably greater than the company's existing claims-paying resources."

Since FGIC has been unable to raise additional capital to date, the bond insurer will likely seek to terminate or commute some credit default swaps in exchange for a fee after another guarantor, Security Capital Assurance SCA.N, and Merrill Lynch MER.N set a precedent for such transactions on Monday.

Given the bond insurer's greatly weakened financial condition, Fitch said it would evaluate any commutation to judge if it was distressed and viewed as an economic default.

The rating agency also cut the holding company's debt rating deeper into junk territory, to "CCC-minus" from "BB".

That's because regulators, if they intervened, would likely prevent the bond insurer from paying dividends to the holding company, which uses them to service its debt or pay for other operating expenses.

FGIC, whose owners include PMI Group (PMI.N), Blackstone Group (BX.N), Cypress Group and CIVC Partners, guaranteed about $313.9 billion of debt at the end of 2007. (Reporting by Anastasija Johnson; Editing by James Dalgleish)