While financial guarantors have navigated the rough waters of the current economic downturn reasonably well, questions persist over exposure to troubled sectors of the ABS market as well as increased competition that may lead to decreased underwriting standards for monolines. Moody's Investors Service addresses these concerns in the recently issued Financial Guarantor Industry Outlook, in which the rating agency concludes that while its outlook for the industry remains stable, "the occurrence of certain adverse events or developments could potentially change our view."
But Moody's points out that the current crossroads is an unprecedented one for the financial guarantor industry. "Given their exposure to consumer ABS and MBS transactions, as well as corporate risk embedded in CDOs and other commercial structured vehicles, the current economic downturn may be the first true test of the financial guarantors' expanded business strategy."
Moody's main concern seems to be the competitive aspect of maintaining market share. With eight insurers now offering primary market insurance - versus the four traditional names - Moody's is concerned that increased competition may lead to either decreased premium fees or a lowering of underwriting standards in order to penetrate new markets, particularly non-U.S. markets.
What is most likely, according to Moody's, is that the guarantor market becomes segmented, with the triple-A rated guarantors focusing on more traditional markets, while some double- and single-A rated guarantors "may focus on markets and risks that are distinct from the target markets of the Aaa-rated companies, thereby limiting direct competition among these players," Moody's adds.
Areas for non-U.S. growth in the near term are European markets, which have undergone a significant amount of privatization, primarily in the U.K. This has led to a boom in European project finance, described as "complex, long-tailed transactions that are very large in size." Insuring project finance typically increases the single-risk exposure of a guarantor, at only a marginal level of investment-grade-risk taken by the monoline. This makes it "extremely important for the companies to maintain disciplined underwriting and manage risk concentrations carefully over time."
Currently 16% of guarantor's collective par exposure is outside of the U.S., up from 7% in 1998. While this is more profitable than backing domestic issuance, margins have declined in the past five years, as insurers have cut premiums to gain market share. A large percentage of the overseas growth over this time frame has been in CDOs, which has "eroded premium averages," due to increased competition.
While "capturing international business has been an ongoing challenge" for the industry, "when comparing the expectations of five years ago with current performance, Asia was expected to be a significant contributor - this has yet to materialize," said the report.