Financial Security Assurance Inc. is transforming itself into one of the strongest financial guarantors, despite additions to the firm's loss reserves, according to Standard & Poor's Corp. and Moody's Investors Service.

In an upbeat report, Standard & Poor's affirmed FSA's AAA rating with praise for underwriting, capital adequacy, management, and overall evolution.

The insurer's "capital adequacy margin of safety," one of the agency's bedrock measures for determining financial strength, has undergone "substantial improvement," the agency said in the June 15 report.

Moody's Investors Service agrees, saying FSA has bolstered its various lines of business.

"They've done a number of things which have changed the outlook for their insured portfolio," James F. Schmidbauer, assistant vice president at Moody's, said yesterday. "Generally, it's perceived as a strategy with less risk."

William I Jacobs, executive vice president and chief operating officer at FSA, said the firm's entrance into the municipal insurance market has been instrumental in boosting capital strength.

"We've got these other [monoline] companies a little bit concerned about us," Mr. Jacobs said.

Assessing FSA's personnel, Standard & Poor's wrote, "The management team has excellent credentials in the fields of investment banking, law, commercial lending and credit, insurance, and marketing."

The positive tone of the report is notable in light of FSA's recent spate of loss reserves.

The company added $22.8 million to its reserves in the past six months due to two Days Inn deals that went awry, and the insurer may establish a small reserve in relation to an asset-backed transaction secured by Heron International, the London-based commercial real estate developer suffering a cash crisis.

Robert Green, author of the Standard & Poor's report, said he expected such a loss reserve, but declined to specify how much would be set aside by FSA due to ongoing negotiations between Heron and its creditors.

The Standard & Poor's margin of safety is an expression of a financial guarantor's capital resources available to pay claims in a hypothetical depression scenario. A ratio of 1.0 to 1, deemed "marginal" for triple-A bond insurers, was calculated for FSA two years ago.

In the interim, however, FSA has boosted that figure to about 1.35, marking significant improvement in the company's capital position, the report says. The 1.35 level also matches the average of all monoline companies, including municipal reinsurers and Capital Markets Assurance Corp.

Municipal Bond Investors Assurance Corp. and AMBAC Indemnity Corp. have safety margins of 1.35, while Capital Guaranty Insurance Co. has a margin of 2.55 and Financial Guaranty Insurance Co. has a 1.15 safety margin, according to the most recent data from Standard & Poor's.

Much of FSA's strengthening has been the result of its asset-backed management. Asset-backed transactions have shorter durations than municipal guarantees, and as the deals have "run off" in the last two years, FSA has been writing increasingly conservative business, the Standard & Poor's report says.

"As we've gone into municipals, the business gets less risky," Mr. Jacobs said. "When the old asset-backed deals run off, we're putting on quality business. We're getting a double impact on capital charges and getting stronger over time."

Analyses of three red flag lines of business -- commercial mortgages, highly leveraged transactions, and higher-risk asset-backed deals -- underscore the transformation, Standard & Poor's says. Whereas at yearend 1989 34% of FSA's net insurance portfolio was in these securities, the proportion fell to 24% by the end of 1991. And such deals were only 2% of the net par amounts underwritten last year, Standard & Poor's noted.

Moody's has a similar opinion of FSA's changing business. Mr. Schmidbauer said the firm's recent decision not to guarantee any more commercial real estate "reduces the risk profile associated with their business."

"Since they made their municipal effort," he continued, "and have focused on housing agency [securities] as well as residential mortgage paper, the sector characteristics are clearly of a lower-risk nature."

FSA's commercial real estate business, renounced April 15, included a $405 million mortgage-backed note deal guaranteed by Heron. Due to reinsurance, collateral, and Heron's first-loss position on the deal, FSA's loss reserves, if any, would be very small.

"The FSA management is in the process of gathering information to determine if a loss reserve is necessary," Mr. Schmidbauer said.

"Heron has announced that they'll meet all their liabilities," Mr. Jacobs said. "We're studying our prospects. We're in as good a shape as any other creditor."

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