Feeling Enhanced: The Wacky World Of Insurance

Gone are the days when securitization deals were either wrapped or unwrapped. These days securitizers can select deal enhancement from the traditional monolines, international agencies such as the International Financial Corp. (IFC), and the World Bank; multiline insurers, such as Zurich U.S.; and U.S. federal agencies, like Overseas Private Investment Corp. (OPIC).

"With the wide variety of insurance policies out there, investors should be aware of what is being covered and what is not," said Rosario Buendia, director of the structured finance department for Latin America at Standard & Poor's.

Monoline Insurers Total Protection

Monoline insurers are, by definition, companies with a single line of business. They provide full guarantees of principal, interest and timeliness of payments.

Monolines try not only to control the risks on any given transaction but also to control the risk within their entire insured portfolio. "These insurance companies realize that one of their greatest risks is accumulating a portfolio where correlation would be high," said Jack Dorer, senior vice president at Moody's Investor Services. "That's why they focus on establishing a well-diversified portfolio with a low-risk content and stick to the more developed countries, where risks are more contained."

Triple-A rated monoline insurers, such as MBIA Insurance Corp., Ambac Assurance Corp., Financial Security Assurance, Financial Guaranty Insurance Co., normally require that securitizations are backed by a real asset that is being paid for in hard currency and that the underlying deal is rated at investment grade level by Moody's and S&P (others, such as double-A rated Asset Guaranty Insurance Co., are able to write insurance for sub-investment grade deals).

Multilateral Financial Institutions

Undoubtedly, the international standing of multilateral financial institutions adds strength to the transactions they back, yet there are some important distinctions in regards to the coverage they give to investors. The World Bank acts as a loan guarantor and therefore makes payments of principal and interests if the issuer does not meet payments. In contrast, the IFC and the regional multilateral agencies, such as the Inter-American Development Bank (IDB), do not provide a full financial guarantee but rather issue loans under their preferred creditor status.

This preferred creditor status means that even in the event of a national currency crisis governments usually encourage debtors to make good their debts to the multilateral agencies; for instance, exempting them from the imposition of exchange, transfer or convertibility controls. Thus, the rating is not constrained by the sovereign foreign currency rating, but instead can be assigned a foreign currency rating equal to or higher than that of the issuer's local currency rating.

In order to qualify for inclusion under the preferred creditor umbrella the sovereign government has to have a history of non-interference in private sector payments to multilateral institutions, as well as be well integrated into global trade and financial systems.

Deals are structured with the multilateral agency as the lender of record and investors purchase participation (securitized or otherwise) in the debt payments that the issuing company owes to those multilaterals. In a crisis, governments are likely to ensure that debtors have access to the necessary hard currency to ensure repayment.

"We believe that even in cases in which foreign currency is being rationed by the government or the government itself is not paying some of its obligations, foreign currency

will be made available for purchase by the company in order to avoid a default to [for example] IDB or the IFC," explained Buendia.

Despite the advantages granted by the multilaterals' preferred creditor status, any deal is only as good as the issuing company, because investors are taking the commercial risk of the company and counting on its ability to generate enough local currency to buy the dollars from the central bank. Since the IFC and the regional multilaterals are not guaranteeing payments to investors, if the company is unable to purchase dollars the deal will default.

Political Insurance The Wave Of The Future?

In that sense, preferred creditor status transactions are similar to the new arrivals of bond insurance OPIC and multilines such as Zurich U.S. as they rely on the issuing company's ability to generate enough local currency to purchase dollars that will determine whether investors lose out.

"Since the ability of the company to generate enough local currency to buy the dollars depends on the company's operating environment which can include scenarios of devaluation, price controls, inflation, etc, the ratings on both the OPIC and the [preferred creditor status] transactions are [as far as S&P are concerned] constrained by the local currency of the company in the transaction," said S&P's Buendia.