Fitch Comments on 'Successor' Issues in FSA-related CDS

Since the announcement last Friday (Nov. 14th) of Assured Guaranty Ltd.'s (AGL) proposed acquisition of the financial guaranty business of Financial Security Assurance Holdings Ltd. (FSA), Fitch has received questions concerning the transaction's impact upon credit default swaps (CDS) involving FSA as a reference obligation.

In response, the following commentary focuses upon the likely outcome for CDS involving FSA, particularly the potential for the acquisition to trigger a 'succession event' in CDS that reference obligations of FSA and its subsidiaries.

In order to assess the likelihood of 'succession events' (under the rules-based approach set forth in ISDA 2003), an understanding is needed of how the acquisition transaction will change FSA's current corporate and debt structure. It should be noted that a wrapped security may be considered a 'qualifying policy' under the 2005 ISDA language, and, being analogous to a 'qualifying guarantee,' is thus deliverable into a CDS contract referencing a financial guaranty company (not the holding company), should a credit event occur. (For more information on successor events in CDS, refer to Fitch Special Report 'CDS Update: Corporate Restructurings and LBOs Refocus Market on CDS 'Successor' Language', dated April 21, 2006., and 'The CDS Market and Financial Guarantors - Current Issues', dated Feb. 27, 2008.)

For the purpose of this analysis, obligations of FSA and its subsidiaries can qualitatively be divided into several categories:

-- Outstanding insured obligations of Financial Security Assurance Inc. (FSA Inc.) - the primary financial guaranty entity. FSA Inc.'s insured portfolio on a gross par basis as of Sept. 30, 2008 totaled $548 billion, and the majority was insured via financial guaranty policies, rather than CDS. FSA Inc. has no outstanding public debt.

-- Outstanding direct debt of FSA - the current holding company. As of Sept. 30, 2008, FSA reported outstanding direct debt of $730 million.

-- Outstanding obligations of FSA's financial services business subsidiaries and affiliates. These obligations are primarily either 'guaranteed investment contracts' (GICs) or medium term notes (MTNs). The GIC obligations are issued by subsidiaries of FSA, and the MTNs are issued by partially owned affiliates of FSA. Both the GIC obligations and the MTNs are insured by FSA Inc.

AGL has disclosed its current plans regarding several key aspects of the post-acquisition corporate structure, which are relevant for this analysis:

At closing and for some period afterward, FSA Inc. is expected to remain a separate legal entity, and continue its current public finance and infrastructure business activities as a standalone financial guarantor. This being the case, Fitch does not expect that the acquisition transaction would constitute a 'succession event' at this time for CDS referencing obligations of FSA Inc.

The future of the holding company, FSA, is currently not as clear. AGL has indicated there is a possibility that FSA will be merged into AGL's U.S. holding company subsidiary. Whether or not FSA is merged into an AGL entity, its currently outstanding debt is expected to remain outstanding, possibly with a guarantee by AGL. If FSA is merged into an AGL entity, it is likely this would constitute a 'succession event' for CDS written on FSA. If FSA continues as a separate legal entity with its current debt structure, Fitch expects that the acquisition would not trigger a 'succession event.'

The financial services entities are essentially special purpose entities, and it is unlikely that CDS have been written specifically referencing their obligations - making the 'successor' issue largely irrelevant for them.

The structure of the transaction contemplates that FSA Inc. will remain the insurer of the financial products obligations, and in any event, these obligations as a percentage of FSA Inc.'s total are of insufficient magnitude to breach the stipulated 25% threshold to potentially qualify as a succession event. Thus, the assumption of these obligations by Dexia would likely not trigger a succession event for FSA Inc. as the guarantor. Fitch will continue to provide commentary as the transaction progresses and additional details become available.

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