As touched upon in several past quarter issues of the Guarantor (see accompanying supplement), monoline bond insurers have been moving out of the home-equity sector over the past year. In fact, according to Thomson Financial, there were no monoline wrapped home-equity term deals in the third quarter, which was somewhat surprising to several long-time market analysts.

However, the current market's credit concerns and desire for liquidity is sparking a significant uptick in wrapped home-equity deals this quarter.

"Though we truly wish it was for a different reason, business has picked up, particularly in the mortgage sector, post-Sept. 11," said a managing director at one of the sureties. "Investors were desiring liquidity in their portfolios, and our guaranties raise both protection against credit risk and provide significant liquidity. "

While activity in home equity and other traditional ABS sectors is increasing for the monolines this quarter, the largest area of growth this year - by far and away - has been synthetic collateral debt obligations, often less visible than their funded counterparts. Though synthetic CDOs were historically a balance-sheet management tool for large institutions, this year marks the beginnings of the arbitrage motivated cousins.

"I've been [in this business] for 11 years, and I've never seen change occur so rapidly," said Dan Farrell, managing director and head of corporate finance at Financial Security Assurance. "This year has been incredible, the way the market has moved, and the different ways the market is utilizing our guaranty."

Outside the box

"Looking back over a number of years, sectors get hot and cold," said Dick Smith, a bond insurance analyst at Standards & Poor's. "You can have a period when home equity loans are going like gangbusters, and then there will be a dynamic shift and all of a sudden insurers are out of that business, because other executions are more attractive."

Ironically, the CDO market, which has been such a strong area of growth for the monolines, is also the market whose sub-bond bid has brought so many ABS issuers away from the wrapped structure.

Beyond synthetics, business has also been good in esoteric areas of ABS, such as one-off net interest margin deals, shipping containers, and other operating lease type transactions, both in the term market and in the asset-backed commercial paper market. Like home-equity deals, an increased use of insurance for esoteric assets is also associated with the tightened credit and liquidity environment, "particularly from thinly capitalized entities," said Kent Becker of Moody's Investors Service.

"We've seen sectors come and go before, and I don't think that anyone sitting here today is thinking that the CDO phenomena over the last 12 to 18 months is going to continue on forever," S&P's Smith said. "But what's important is that over time, the insurers build a diversified book of business."

Interestingly, home equity is where the monolines made their start in ABS back in the early 1990s, as a way to diversify out of municipal finance exposure. Going forward, municipal is expected to make up a smaller portion of the overall bond insurance business. Growth should continue in the emerging ABS sectors, and particularly in the international markets, Smith said.

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