Two municipal bond insurers that until now had avoided the difficulties faced by competitors have had their top financial strength ratings placed on review by Moody's Investors Service.

The rating service said it was examining the "Aaa" ratings of Financial Security Assurance Inc. (FSA) and Assured Guaranty Corp. for possible downgrade. The rating agency cited elevated risks they faced from the residential mortgage market as well as issues with the individual firms as reasons for the review.

Regarding FSA, Moody's said "significant deterioration in the financial conditions of both insurance and asset management operations of FSA, as assessed by our updated analysis...may be inconsistent with the expectations of a "Aaa"-rated insurance company given the operational and strategic sensitivities that such stress may exemplify."

Moody's said that although FSA has avoided the asset backed securities collateralized debt obligations (ABS CDOs) that have stressed other guarantors, the firm is exposed to direct residential mortgage backed securities (RMBS) which have "generated material losses in [FSA's] insurance and asset management operations."

After reassessing FSA's mortgage-related exposures, Moody's said that expected losses from the risks in FSA's direct RMBS portfolio approximated $770 million, and stress-case losses totaled $1.5 billion. Moody's said these figures represent increases of 78 percent and 36 percent, respectively, over previous estimates.

Moody's also cited credit deterioration in FSA's asset management business.

The rating agency added that recent losses have been mitigated through a capital infusion and line of credit extended by FSA's parent, Dexia, but Moody's stated that "such support may not be unconditional or sufficient to entirely mitigate potential risks."

With respect to Assured, Moody's said that its action "reflects elevated risks with the financial guaranty insurance market and within Assured's insured portfolio."

The rating agency said that "recent events have demonstrated that the leverage and complexity of some structured finance transactions have made loss estimations for certain segments of Assured's insured portfolio more difficult, and the variability of those estimations, especially given the guarantor's operating leverage, may be inconsistent with the very low risk tolerance implied by a "Aaa" rating."

Moody's added, "Furthermore, Assured's material exposure to large single and sectoral risk concentrations, which Moody's considers to be higher than other highly rated financial guarantors, creates the potential for significant deterioration to the company's capital position should material adverse developments occur among a few large transactions or within a particular sector of the insured portfolio."

In its reassessment of risks in Assured's direct RMBS portfolio, Moody's said that "stress-case loss estimates on a present value basis did not change meaningfully from prior estimates, approximating $330 million for Assured and $250 million for Assured Guaranty Re Ltd. (AG Re). Furthermore, Assured and AG Re remain modestly exposed to the ABS CDO sector, which did not generate any loss under Moody's stress scenario."

For both FSA and Assured, Moody's said that the decision for a review was also influenced by declining bond insurance volumes in the municipal segment. While Moody's acknowledges that this shift has so far mainly been caused by the recent market turmoil, the rating agency said that alternatives to bond insurance "may negatively influence demand in this sector in the future."

Moody's also called FSA's and Assured's insured portfolios "generally high-quality and well-diversified" beyond the mortgage-related exposures.

Speaking to the scope of its reviews, Moody's said that it will review the characteristics of FSA's and Assured's portfolios that "could make the [companies] susceptible to material losses as seen in the mortgage market."

The rating agency said it will also evaluate the business and franchise sensitivity to an erosion of market confidence. "In addition, Moody's review will consider the likely strategic direction of the firm given the changing dynamics within the industry, as well as the potential implications of any future regulatory changes to the credit profile of the group," Moody's said.

For FSA, Moody's said that the ratings for affiliated insurance operating companies are also on review for possible downgrade, as well as the senior unsecured ratings of the parent company, Financial Security Assurance Holdings Ltd.

For Assured, its wholly owned subsidiary, Assured Guaranty (UK) Ltd., as well as the "Aa2" insurance financial strength ratings of AG Re and its affiliated insurance operating companies are on review, in addition to the "Aa3" senior unsecured rating of its parent company, Assured Guaranty US Holdings Inc., and the "Aa3" issuer rating of the ultimate holding company, Assured Guaranty Ltd. (Bermuda).

Some of the concerns voiced by Moody's were earlier mentioned in a Friday report on monoline financial guarantors released by Fitch Ratings.

Fitch said Assured's underwriting processes and credit profile are sound, and that FSA's underwriting capability and credit profile is "very disciplined," but the rating agency added that ratings could be pressured if the companies are unable to access further capital, if needed.

Fitch also mentioned the possible decline in demand for financial guaranty insurance and the companies' exposure to the RMBS sector as potential concerns.

As of Dec. 31, 2007, Fitch said Assured had about $26 billion of exposure to the RMBS sector, and FSA had about $29 billion.

While noting these concerns, Fitch said FSA's capital position is presently satisfactory to support a "AAA" IFS rating.

For Assured, Fitch said its capital position "was more than satisfactory to support the [AAA] IFS ratings as of the most recent review."