negatively affected by exposure to structured finance collateralised ... (Ambac)
and Financial Guaranty Insurance Company (FGIC) to. 'AA', CIFG Guaranty to ...
Structured Finance Structured Finance/Europe/ Asia Special Report
FAQ: Monoline Financial Guarantors
Analysts
Monoline financial guarantors have become the latest parties to be negatively affected by exposure to structured finance collateralised debt obligations (SF CDOs) backed by US subprime mortgage collateral and to US subprime residentialmortgage backed securities (RMBS). The deterioration in this collateral has affected the financial guarantors’ capital adequacy to the point where the ‘AAA’ Insurer Financial Strength (IFS) ratings of five of the companies have been affected. As of the date of this publication, Fitch Ratings has lowered the ratings of Ambac Assurance Corp (Ambac) and Financial Guaranty Insurance Company (FGIC) to ‘AA’, CIFG Guaranty to ‘AA’, while lowering the rating of Security Capital Assurance Ltd.’s financial guarantee subsidiaries to ‘A’. The latter three companies remain on Rating Watch Negative. The ‘AAA’ rating of MBIA Insurance Corp. (MBIA) has also been placed on Rating Watch Negative.
EMEA
Stuart Jennings +44 20 7417 6271
[email protected] Andy Brewer +44 20 7417 3481
[email protected] Jeffery Cromartie +44 20 7664 0072
[email protected] APAC
Alison Ho + 852 2263 9937
[email protected]
in EMEA/APAC Structured Finance
The challenges facing the financial guarantors have prompted questions from market participants regarding their involvement in European and Middle East (EMEA) and Asia Pacific (APAC) structured finance (SF) transactions and what this means for the ratings of the underlying transactions themselves. This commentary is intended to provide answers to some of the key questions being posed. n
What do Monoline Financial Guarantors do?
Financial guarantors provide financial guarantees (or “wraps”) in the capital markets, which guarantee to pay principal and interest on a bond on a timely basis in the event that the underlying issuer were to default. A bond that benefits from such a financial guarantee is often described as being wrapped. They differ from traditional “multiline” insurers in that their sole focus is upon the capital markets, while multilines offer insurance in a wide variety of other sectors and are not permitted to offer financial guarantees. They also differ from multilines in that they give an irrevocable and unconditional guarantee to pay claims on a timely basis on default of the underlying issuer – multilines will generally only pay claims after a period of “loss adjustment”. n
What Industry Sectors are They Involved in?
The roots of many financial guarantors lie in the US municipal finance arena, guaranteeing bonds by state and local governments. With the growth of structured finance, in recent years, these companies have increasingly expanded into insuring a wide variety of US RMBS, assetbacked securities (ABS) and CDOs. Internationally, financial guarantors also insure infrastructure and project financings, local government issues, structured finance transactions and sovereign and quasisovereign debt.
25 March 2008 www.fitchratings.com
Structured Finance n
published in related presale or new issue reports or may remain unpublished.
Why are They Used in Structured Finance?
Financial guarantors can reduce the cost of funding for issuers where the interest payable on the wrapped notes plus the premiums payable to the insurer is less than might be obtained via, for example, a senior/subordinated transaction structure without such a wrap. In addition, for some issuers, it offers capital markets access and execution that might otherwise be difficult to achieve. The financial guarantee wrap gives comfort to investors who may not otherwise feel comfortable in investing in the underlying credit alone and it therefore may increase the marketability of a note issue due to the insurer’s guarantee of interest and principal payments. n
Where an underlying rating has been assigned, then the rating of the wrapped note tranche becomes the greater of (i) the underlying rating; and (ii) the IFS rating of the insurer. Therefore if the underlying rating without the wrap is ‘AA+’ and the financial guarantor’s IFS rating has been lowered from ‘AAA’ to ‘AA’, a downgrade of the wrapped note tranche would follow, but only to the ‘AA+’ level and not to the ‘AA’ level of the financial guarantor’s IFS rating. n
Yes, in certain circumstances. Even if the underlying rating was initially unpublished, if the underlying rating is upgraded over time, or if the financial guarantor IFS rating is lowered over time, then the underlying rating may eventually exceed the guarantor’s IFS rating. Under such circumstances the underlying rating will become the public rating of the tranche since it now exceeds the financial guarantor IFS rating. In such circumstances, therefore, the underlying rating will be published.
Will Wrapped Note Tranches Always be Rated ‘AAA’ When the IFS Rating of the Monoline is ‘AAA’?
Yes. Where a note tranche benefits from a wrap, that note tranche will reflect a minimum rating for its longterm rating equivalent to the financial guarantor’s IFS rating. Until the recent downgrades, most prominent financial guarantors retained ‘AAA’ IFS ratings. While this remains the case, the rating of the wrapped note tranche will also receive an ‘AAA’ longterm rating.
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Therefore, while the financial guarantor’s IFS rating remains ‘AAA’, the credit quality of the underlying assets securing the note issue has no influence on the note’s longterm rating – it will always be ‘AAA’ in such circumstances. n
Where the Underlying Rating was Initially Unpublished, Could it Eventually Be Published?
What Exposures to Financial Guarantors are There in FitchRated EMEA/APAC Structured Finance Transactions?
In terms of primary issuance, there is minimal primary exposure to financial guarantors within the EMEA/APAC structured finance transactions that are rated by Fitch. The vast majority have public underlying ratings, many of which were published following recent financial guarantor IFS downgrades when those underlying ratings came to exceed the new lowered IFS rating. A spreadsheet of EMEA/APAC SF monoline financial guarantor exposures has been published alongside this report.
If the Financial Guarantor has a Lower Rating Than ‘AAA’ (or is Downgraded Below ‘AAA’), will the Wrapped Tranche Always have a LongTerm Rating at the Same Level (or be Downgraded to the Same Level)?
Not necessarily. The question of where the credit rating of the wrapped tranche will then lie depends upon two things. Firstly, it will depend upon whether the underlying note tranche has been assigned an underlying rating in the absence of the financial guarantee wrap, which has also been maintained on an ongoing basis. Secondly, if such an underlying rating was assigned, it will depend upon the current level of that underlying rating. In the case of EMEA and APAC SF, all wrapped transactions have underlying ratings.
ESF APAC Monoline Exposure March 2008 ─ amon2503.xls The overall primary exposure to financial guarantors within EMEA SF amounts to GBP8,427m. Of this, some 70.2% by outstanding principal balance relates to tranches wrapped by Ambac, with a further 21.1% relating to tranches wrapped by MBIA. The overall primary exposure to financial guarantors within APAC SF amounts to GBP706m. Of this, some 53.4% by outstanding principal balance relates to tranches wrapped by MBIA, with a further 46.6% relating to tranches wrapped by Ambac.
Often, the financial guarantor may request an underlying rating of the note tranche at closing to assess what rating the tranche would have received without its wrap. Such an underlying rating may be
FAQ: Monoline Financial Guarantors in EMEA/APAC Structured Finance: March 2008 2
Structured Finance involves a securitisation of aircraft loans originated by Air France. For the most part, the guarantor IFS ratings remain above the underlying ratings of the securities.
Residential MortgageBacked Securities (RMBS)
RMBS exposure to financial guarantors in the EMEA region amounts to 20 tranches, with an outstanding principal balance of GBP741m representing just 0.6% of the outstanding number of Fitchrated European RMBS tranches. Exposure in this asset class is limited to seven UK non conforming transactions, most of which are three or four years’ seasoned. All of the tranches have underlying ratings that have seen upward rating migration over time, such that they either equal or exceed the guarantors’ IFS rating.
No Fitchrated APAC ABS transactions have financial guarantor exposure. Whole Business
Whole business insured exposure to financial guarantors amounts to 15 tranches, with an outstanding principal balance of GBP3,748m. This represents almost 17.6% of the outstanding number of Fitchrated whole business tranches. All of the wrapped tranches are from transactions secured on public house portfolios in the UK. For the purposes of this report, whole business is defined as transactions secured by public house or care home portfolios only.
Exposure to financial guarantors in Fitchrated APAC RMBS transactions is limited to three Korean and one Australian deal. All affected tranches remain at ‘AAA’ with no Rating Watch placement, despite the financial guarantors concerned having either been downgraded or placed on Rating Watch Negative. This is because the underlying ratings are all at a ‘AAA’ level.
No such wrapped whole business tranches exist within the APAC region. AssetBacked Commercial Paper (ABCP)
Commercial MortgageBacked Securities (CMBS)
European assetbacked commercial paper (ABECP) insured exposure to financial guarantors is largely restricted to some securities transactions and underlying portfolios within two conduits, Scaldis and Check Point Charlie. The conduits include securities wrapped by a number of different financial guarantor names. Financial guarantee exposure within Scaldis is estimated at 15% of the conduit portfolio, while that for Check Point Charlie is currently 9.3%. In the event that the underlying securities saw downgrades as a result of insurer downgrades then this could affect the credit enhancement levels required.
Commercial mortgagebacked securities (CMBS) exposure to financial guarantors amounts to 13 tranches with an outstanding principal balance of GBP2,348m, representing 1.3% of the outstanding number of Fitchrated European CMBS tranches. Exposure is limited to one Italian and two UK transactions. The two UK transactions involve income from operational British Telecom properties and BBC Broadcasting House, respectively, while the Italian transaction involves the refinancing of a transaction backed by income from the sale and leaseback of a portfolio of Telecom Italia properties. For four tranches in one of these deals, the underlying rating now exceeds that of the IFS rating. However, the underlying ratings for the other tranches and deals remain below the guarantors’ IFS ratings and in these cases were also provided on a private basis.
However, credit enhancement for these conduits is calculated on a dynamic basis, such that it would reset to reflect the securities’ new rating levels. In the event that dynamic credit enhancement levels were not maintained, this would prevent the conduit from issuing commercial paper and backstop liquidity facilities would likely be drawn to repay maturing CP. There are no European ABCP conduits where the programmewide credit enhancement is provided by insurers.
No Fitchrated APAC CMBS deals have financial guarantor exposure. AssetBacked Securities (ABS)
ABS exposure to financial guarantors amounts to GBP1,190m, representing about 0.2% of the outstanding principal amount of Fitchrated European ABS tranches. Four transactions include wrapped tranches, one each from the UK and France and two from Italy. The Italian transactions involve health authority receivables guaranteed by the Region of Lazio. The UK transaction involves a securitisation of ticket receipts from Arsenal Football Club’s stadium. The French transaction
Collateralised Debt Obligations (CDO)
Only one Fitchrated European CDO transaction, Freshwater Finance (a repackaging of bonds issued by Anglian Water Services Financing plc), was structured with primary monoline financial guarantee credit protection. However, 300 European Fitch rated synthetic CDOs that reference corporate portfolios are exposed to monoline financial guarantees via credit default swaps. If monoline
FAQ: Monoline Financial Guarantors in EMEA/APAC Structured Finance: March 2008 3
Structured Finance financial guarantors suffer further downward rating migration, then this will affect the performance of those CDO transactions. Most of the CDOs referencing financial guarantors are “inner CDOs” from “CDO squared” (or CDOs of CDOs) structures. For example, one CDO squared structure or “master level” CDO may reference 20 “inner CDOs”, each of which reference a portfolio of 100 or more corporate names. While master CDOs are generally rated, inner CDOs are often unrated. For master level surveillance purposes, Fitch currently tracks 403 unrated inner CDOs with exposure to financial guarantors. As CDO squared structures are highly leveraged, poor performance in underlying sectors can be further magnified in the rating performance of the structure itself.
exposures to entities that underwent LBOs, resulting in significant downgrades to speculative grade levels. Given that financial guarantor ratings are still well within investment grade territory, despite recent downgrades, financial guarantor rating migration alone is not expected to result in downgrades of these structures. No Fitchrated APAC CDO transactions have primary financial guarantor exposure. However, there are seven APAC CDO transactions whose underlying charged assets are either invested in securities issued by, or wrapped by, financial guarantors. Of these seven transactions, three are publicly rated deals that have charged assets in securities issued by or wrapped by MBIA Insurance Corp, namely Morgan Stanley ACES 200632, Morgan Stanley ACES 200634 and Hickory Trust Synthetic CDO. The other four transactions were rated on a private basis and have charged assets in securities issued or wrapped by AIG.
While CDOs of CDOs are exposed to financial guarantor risk, there have been no downgrades as a result of such exposure. Historically, CDOs of corporate CDO have been downgraded due to exposure to underlying defaults or underlying
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FAQ: Monoline Financial Guarantors in EMEA/APAC Structured Finance: March 2008 4
