Last month Citibank priced its Project Securitization I CLO within original price talk (see ASR 8/6/01) despite a credit downgrade of its financial guarantor, Assurance Generale de France, a subsidiary of Allianz AG. Ironically the triple-A wrapped notes were rated one notch above its reinsurer.

Of course, the A class was rated triple-A on a stand-alone basis, based on credit enhancement levels and the underlying assets. Still, watching the multilines' ratings fall below the deals they're insuring may be an increasingly scenario in the securitization market, as transparency in the European insurance industry has equity investors demanding more value on returns. Entertaining a triple-A insurance rating means maintaining large pools of reserves that could be put to better use, say analysts at Standard & Poor's.

"The insurance market has been subject to a number of accounting and reporting changes that have led to shareholders' better understanding of the economic value of insurance businesses and therefore perceiving many triple-A-rated companies as unprofitable in terms of return on equity," stated a report from S&P.

Today's competitive pressure in the insurance market is leading some companies to better leverage their balance sheets which ultimately translates into forgoing triple-A assessments, much like the July downgrade of Allianz. The insurer's acquisition of Germany's third largest bank Dresdner AG, although viewed as largely profitable, also exposed the company to the bank's weaker businesses, say market sources. Allianz was consequently downgraded to double-A plus from triple-A.

Such a downgrade should do little in terms of a company's ability to underwrite securitization wraps, because these companies tend to cater to customers that do not necessarily need a triple-A backed insurer in order to enhance transactions. "The game is not all about triple-As," said Christian Dinesen an analyst at S&P and author of the report.

The CLO did not suffer from the downgrade of its guaranty provider because its wrap was meant only to enhance the triple-A notes. In the event of a downgrade, the class-A notes would suffer no repercussion. The wrap was instead used to provide assurance that if the already triple-A rated notes were to suffer credit deterioration, the notes would theoretically benefit from the class A credit enhancement.

While S&P remarked in the transaction's pre-sale report that since "AGF would be the controlling class of the transaction, certain actions taken in this limited capacity might affect the credit quality of the portfolio and the rating on the class A notes." Yet, it expected the final documents of the deal to state that the credit enhancer would not adversely affect the current ratings of the senior notes.

It is likely that many companies will consider the double-A rating appropriate because for large companies such as Allianz, the capital reserves of this new rating can still manage leverage and concurrently increase return on equity, explained Dinesen.

Triple-A, a monoline's business

For monolines, maintaining a triple-A credit is what their business is founded on, thus considering a downgrade to enhance returns is not an issue for these institutions who are likely to get a better return on a triple-A wrap. "We are a monoline bond insurer," said a spokeswoman for Financial Security Assurance. "Our value in the market is priced on our triple-A rating."

But insurers with multiple lines of business opting to maintain a triple-A rating must charge triple-A prices, else their returns will disappoint shareholders. "It's a price that some customers might not be prepared to pay," said Dinesen.

Case in point, the above mentioned Citibank Deal was structured to include a collateral pool of project finance loans from emerging markets originated from various sectors which do not appeal to the monoline insurer. "These loans represented real challenges that we would not do on a stand-alone basis," said a market source from a monoline insurance company. The option to go via a monoline route, in this case, was not as pertinent as the class-A tranche was rated triple-A based on the deal's underlying assets.

"People for whom being a triple-A is part of their business position will do everything it takes," added S&P's Dinesen. Alternatively, those companies who are feeling the strain to increase return on equity, maintaining a triple-A might mean sacrificing the economic value of their business. As more companies follow Allianz, it's likely that shareholder pressure will maintain the momentum.

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