Moody's reviewing FSA's financial strength rating

FSA, a unit of European bank Dexia, currently carries a top-notch "Aaa" rating from Moody's for its financial strength, which is vital for the bond insurer's ability to book new business.

Risk in FSA's portfolio, shifts in demands on bond insurers and a potential weakening of franchise value and financial flexibility if losses rise have led Moody's to review the company's financial strength, the ratings agency said in a statement.

Responding to the downgrade review, FSA Chairman and Chief Executive Robert Cochran said in a statement, "We take note of the concerns Moody's has expressed, and we will work closely with them to re-establish our Aaa-stable claims-paying ratings."

Moody's noted that a downgrade would likely be no more than two notches to "Aa2."

Since late 2007, bond insurers have faced mounting pressure from investors, and ratings agencies worried that a potential spike in claims tied to mortgage-backed securities and other risky debt. As mortgages have increasingly defaulted over the past year, investors and ratings agencies widely expect bonds and debt backed by the troubled loans would likely default as well.

Ratings agencies have been worried that the spike in claims would reduce reserves from bond insurers to leave them without enough spare cash to warrant a top-notch rating.

Continued deterioration in credit markets is likely to reduce new business generation as well, ratings agencies have said.

FSA was one of the few remaining bond insurers that had yet to be downgraded by ratings agencies amid the deterioration in the credit markets. One other bond insurer that still maintains top-notch ratings, Assured Guaranty Ltd., was also placed on review Monday night for a potential Moody's downgrade.

Other bond insurers, such as Ambac Financial Group Inc. and MBIA Inc., have seen their new business decline after their ratings were cut by Moody's as well as Standard & Poor's and Fitch Ratings.