Fitch cuts "AAA" rating of FGIC insurance unit

By Dena Aubin

NEW YORK (Reuters) - FGIC Corp's bond insurance arm lost its top "AAA" rating from Fitch Ratings on Wednesday, a blow to the insurer's business model, which could also cause downgrades to more than 100,000 municipal bonds.

Fitch cut FGIC's "AAA" insurer financial strength rating by two notches to "AA," saying the insurer does not have the capital required for a top rating. It also cut parent company FGIC Corp's long-term rating by three notches to "A" from "AA," the third-highest investment grade.

The ratings may be cut again because of uncertainty about the company's business model, losses and capital strategy, Fitch said in a statement.

FGIC is owned by a group including mortgage insurer PMI Group Inc (PMI.N) and private equity firms Blackstone Group (BX.N), Cypress Group and CIVC Partners LP. The group agreed to acquire FGIC from General Electric Co (GE.N) in 2003 for about $1.675 billion.

Top ratings are crucial to bond insurers because without them, their insurance loses much of its value. The insurance has also allowed states and cities to sell debt with top ratings, lowering their borrowing costs.

Fitch warned in December that the loss of FGIC's "AAA" rating could also trigger downgrades to as many as 114,800 municipal bond issues it insures.

FGIC is the fourth-largest bond insurer, with about $314.8 billion of outstanding bonds insured as of the end of September, most of it municipal bonds. The total also included about $31 billion of mortgage-backed securities and $28 billion of collateralized debt obligations.

The ratings cut added to selling pressure in the stock market, where concerns about downgrades of bond insurers had already triggered selling. For details, see .N

PMI's shares closed at $9.11, down from $9.65 before the ratings action.

Like other bond insurers, FGIC initially focused on municipal deals, and later ventured into structured products to boost returns.

But massive defaults on U.S. subprime mortgages battered the credit quality of these products, increasing the capital bond insurers need for a "AAA" rating.

Fitch said FGIC's capital deficiency, which was more than $1 billion when it put the rating on review on December 17, has grown to about $1.3 billion.

"When rating agencies were ranking all the insurers when this all started a few months ago, FGIC was always on the bottom of the list," said Daniel Solender, director of municipal bond management at Lord, Abbett & Co. in Jersey City, New Jersey. "This one is not a surprise. It continues the trend."

All three major ratings agencies have been reviewing bond insurers after warning that their capital may be inadequate for their ratings.

Fitch Ratings cut its top rating on Ambac Financial Group's (ABK.N) insurance unit on January 18 and on Security Capital Assurance's SCA.N insurance arm XL Capital Assurance on January 24.