Bond insurer FGIC said on Wednesday that its exposure to mortgage losses exceeded legal risk limits and it may raise loss reserves due to litigation related to a stricken German bank.
FGIC, the parent of bond insurer Financial Guaranty Insurance Co., earlier this month filed a lawsuit accusing the German lender IKB of fraud in providing incomplete information on $1.9 billion of debt that FGIC agreed to insure.
FGIC in a statement also said it has a substantially reduced capital and surplus position through December 31. As a result, insured exposures exceeded risk limits required by New York state insurance law, FGIC said.
"This is a bombshell," said Rob Haines, senior insurance analyst at CreditSights in New York. "They are actually in violation of New York insurance law. If they don't remediate this, the state has the ability to take control of the company."
A spokesman for New York Insurance Superintendent Eric Dinallo did not immediately comment.
FGIC in notes to its consolidated financial statements said it plans to submit a plan to the New York superintendent to reduce its risk. FGIC also said it has voluntarily ceased writing new business to preserve capital.
"Management is assessing whether the loss reserve related to the commitment agreement needs to be adjusted in the future to reflect the impact of these developments," FGIC said in a statement. "Any such adjustment could be material."
Bond insurers have been facing increasing pressure on their ratings as some companies expanded into insuring complex debt tied to deteriorating U.S. mortgages.
The bond insurers were not alone in overreaching. Once a little-known lender, IKB took center stage last year as Germany's first subprime casualty when its investments in the market for risky U.S. mortgages soured.
The affair has become an embarrassment for Germany as a banking center, and the government has stepped in to try to save the bank from collapse.
IKB is due to hold its annual general meeting on Thursday in Duesseldorf.
S&P Rating Cut?
FGIC has been cut by all three main rating companies recently, limiting its ability to insure bonds and generate new business.
Standard & Poor's said on March 21 that it may downgrade FGIC and its insurance arm due to a decision by the bond insurer's principal owner, PMI Group , not to put more capital into FGIC.
PMI shares were down 8.4 percent at $6.37 in afternoon trading on Wednesday.
S&P had stripped FGIC's insurance arm of its top "AAA" rating in January and now rates the company "A," the sixth-highest rating. It rates FGIC Corp "BBB," the second-lowest investment grade.
Unlisted FGIC posted a fourth-quarter loss of $1.89 billion from its exposure to collateralized debt obligations related to asset-backed securities.