Monoline insurers have acquired a higher profile in European structured finance markets, and at the Global ABS conference in Barcelona they were hailed as the unsung heroes of this business. Increasingly, however, market players are asking if wraps are worth the reduced spread margins.
"In the case of execution, especially with a new transaction, having a monoline wrap certainly makes it a lot easier to get the deal done," said one market source at the conference this year. "But as an investor you must recognize that you are buying a single-A piece that was wrapped triple-A. Most will still look at the underlying, because there is a need to get comfortable with the deal on an unwrapped basis."
It's a trend born from the massive blow-ups that have agonized some credits. While market players agreed that the presence of a monoline wrap is of great importance, they warned that investors must look beyond the financial guarantee to consider the underlying credit on a standalone basis.
Nonetheless, getting comfortable with the underlying doesn't mean that investors would be willing to forego the wrap, said one panelist. "We wouldn't purchase it all alone because there may have been doubts that the applied guarantee would help to bring that securitization into the realm of securities we would like to own," said one panelist.
As a result, deals are increasingly marketed in a wrapped and unwrapped format, allowing investors to get comfortable with the underlying on both levels. And, said panelists, it's a useful tool to review transactions in both formats. In certain established markets, investors are able to recognize that the subordinate is assigned appropriately; in other situations, the enhancement of a guarantee provides a needed level of comfort.
"Sometimes you get complaints from investors who feel that they have spent so much time looking at the deal that they feel comfortable with it without the wrap," said one source. "But because it's offered at triple-A, instead of buying it 60 basis points over Libor they have to buy it at 30 basis points over Libor."
It's clear, however, that the hail of praise for monolines is largely directed at their role in synthetic securitizations, where the financial guarantee opens the door to a larger pool of investors. "If you can bring investors into a class, it definitely improves liquidity," said one source. "In situations that tend to make investors uncomfortable, such as a CDO of CDOs, having a senior tranche wrapped lets investors get in without taking too much risk."
In general terms a wrap will improve liquidity, but it can only function as such as long as it maintains its triple-A rating.
Memories of last year's Hollywood Funding multiline fiasco - where the insurer disputed payments to the claim - make it absolutely vital that the work gets done on the underlying. Panelists said that as a result, investors are drawn to the monolines' history of paying on a timely basis.
One panelist from UBS Warburg said that over the last six months, the transactions that the team has worked on have all had monoline wraps. Although this is not necessarily indicative of the future of multiline providers, it does highlight that, for right now, the demand is there only for monolines.
But consolidation in the monoline industry between medium-sized players could result in liquidity concerns as a result of consolidating risk exposure into a single name. "One has to look at documentation," said one panelist. "It doesn't matter if it's multiline or monoline - one has to see it's their natural interest to pay on time. Some multilines have a quite horrible record in structured finance, because insuring financial transactions is a different business that insuring your house or your roof."
It's essential that investors are comfortable with the insurer's commitment to the financial guarantee business. Small insurers, for example, could find it more economical to just walk away from the whole business rather than to pay up on a claim.
With monolines gaining greater acceptance, panelists warned of the danger of getting caught up with the same names.
On a triple-A level, some investors might find that they have guarantees backed by the same name, and consequently need to look to other insures to diversify holdings. "To have new players is crucial," said one panelist. "We would like to see new players enter this business."
Creating these new players is not an overnight process, however. To date, only a small number of companies have generated interest, and establishing a name in a competitive market - even under ideal conditions - could prove difficult.
"With more new entrants it's certain that not all will be successful," said one panelist. "So you have to be careful to back the right company. In the event of a credit blow-up, you want to make sure that your monoline is willing to pay up first and discuss later."