When FGIC set up shop in the U.K., it initially got its feet wet in the CLO market as a means to generate cash flow. Three years down the line, with its current 20-member team, the company now looks to its infrastructure side as its bread and butter. Although market dynamics on the structured finance side continue to squeeze out the monoline's value, Tim Travers, CEO of FGIC London, said that there are still some opportunities in the securitization market.
The first year FGIC opened its offices in London, it completed eight CLOs. However, over the past 18 months, it has pulled back on this strategy because European deals tend to price tighter than in the U.S. for what amounts to be the same risk. Travers said that these transactions offer little in the way of arbitrage and have, subsequently, become less of a focus for FGIC's European operations. Most of the CLO business the firm does these days is seen from a global platform and generally executed via FGIC's stateside operations.
"Instead of getting seven or eight basis points in Europe, we can get 10 or 11 basis points in the U.S. just because they tend to price wider there," Travers said. "CLOs are really only a form of execution, not necessarily an asset class, because you can put almost any kind of underlying bond through this structure. Why should we have two disparate teams looking at the same product? By creating a global team and doing it through the U.S., we get paid better; meanwhile, we have better control of the quality and management." Travers added that his team now has a better handle on internal controls and portfolio issues with the business handled under one umbrella.
Infrastructure is the hot ticket now in Europe and will probably be for a while, but a lot of this business is executed on a private basis. Travers said utility deals were particularly big for monolines in 2006, with around GBP3 billion ($5.8 billion) sold - and all of it was wrapped. "Basically the bonds were sold to a bank, and the bank ends up wrapping it after the fact," he said. "All of the monolines played in that space - FGIC represented approximately 10% of that business." Utilities have, once again, emerged as an active space in 2007, but activity within this segment of the market is not visible because all the assets are swapped toward a negative basis type of execution, which is not apparent to the real world.
Travers said that the reason these utility-type deals were in such favor is a result of the U.K. government issuing the 50-year index link, which became a perfect benchmark for utilities. "They tend to have very long-life assets, their revenues are linked to inflation," he explained. "The perfect debt instrument to them is an index-linked piece of paper, and the longer the better."
Although there is plenty of supply coming into the market, it's being met with limited demand from real cash investors. That is where the asset swappers come into play, said Travers - they basically take an index-linked instrument, put a swap on it and get a floating-rate note on the back of it. Because of the relationship between swap spreads and index-linked-bonds trading, there is very efficient execution. The floating-rate note pays the investor well, and the utility ends up with a very low-cost, index-linked instrument. The curve has flattened out this year, so utility issuance has dropped off somewhat, Travers said, but there is still a steady supply coming through that provides a good source of income for monolines.
The other side of infrastructure that drives FGIC's business is the U.K. PFI sector. PFIs generally take longer to execute - deals can take anywhere from 18 months to five years in longer instances. These deals are done for companies that require very specific tailoring, so there is no cookie-cutter approach that has facilitated the execution of these deals. Travers said the process could be long and painful. In fact, the first mandate that FGIC received in the PFI space was Peterborough Hospital in February 2005. The deal was initially slated to close by September 2005, but 18 months later, the deal hasn't closed yet. Travers said it is not unusual for deals in this space to take this amount of time because they are typically done every 30 years, so issuers can afford to be more cautious. The U.K. Treasury last year reined in healthcare deals because they were not sure the model made economic sense. They scaled back a number of projects and eliminated some others as well as questioned the value for money proposition. "It is prudent for the government to see if the PFI model for hospitals makes sense and I think they realize that it does," Travers said. "The capital investment that healthcare needs in this country far exceed the balance sheet capability of the government to provide it. The PFI model allows the government to just fund debt service on an ongoing basis and the government also gains certain operational efficiencies by shifting some of the operating risk to qualified third parties."
Market innovation has also shown up in the PFI space, as in the case of the repackaging of the Birmingham Hospital project debt though the RBS sponsored Bishopsgate vehicle. "Where FGIC had already wrapped the indexed linked bonds that were sold by the trust, we also wrapped the floating rate liability that was coming out of the vehicle. Included in that structure was a swap, which was key to the transaction," Travers said. "By guaranteeing the bonds bought by the vehicle, we are guaranteeing the indexed linked cash flows into the swap. We also built in protection to ensure that if the swap provider was ever downgraded they would have to collateralize their swap position or if they were downgraded below single-A-, the swap provider would have to replace themselves."
"In other words, we are really on both sides of the trade, the cashflow into the vehicle and the cashflow coming out of the vehicle are guaranteed and we just make sure that the swap guarantee in the middle really covered the cash flow of the hospital. All of this was necessary, in order to achieve the triple-A ratings needed on the liability side of the deal to sell the Bishopsgate bonds." For 2007, FGIC already has mandates in PFI for six different transactions, of which three to four are expected to come to market this year.
Travers said there are a number of deals that have been place via European conduits. For instance, HSBC uses its Freshwater conduit, which saw a couple of utility deals put through it last year. Bishopsgate was used for a couple of utilities deal as well. These conduits allow the market to turn one instrument into another. "Utilities and PFI deals all have the desire to issue index linked debt because their revenue are tied to inflation but the universe of buyers for this type of paper is limited," he said. "So you have a mismatch between supply and demand. Bishopsgate like vehicles allows market participants to transform the indexed link paper to floating rate paper, for which there is a lot of demand."
Structured finance, on the other hand, has proved more disappointing, especially since the company pulled back from European CLOs. The asset classes FGIC was counting on in terms of its earlier business plan just haven't been there. The whole business has seen limited flow. U.K. pubs have shifted from a whole business format to more opco/propco-styled deals, and investors have generally become more comfortable with this asset class over the years. The economics for monoline participation is no longer there.
Subprime RMBS, another area FGIC had hoped to build on has not provided any opportunity for business. Perhaps a blessing in disguise considering the current environment, though Travers said that the U.S. woes haven't really manifested themselves in the same way on U.K. deals. "We were counting on periodic issuance where we could actually wrap a primary deal for a GMAC-RFC or Kensington Mortgages but nothing has been there primarily because spreads are too tight," Travers said.
The last monocline-wrapped U.K. subprime RMBS deal was done in June 2005. Travers said that FGIC had positioned itself to enter the market in September of that year, hoping to wrap a RFC deal. By the time September rolled around market spreads had collapsed to the point where it wasn't economic and the presence of their wrap added no value. That hasn't changed, he said, even with the news in the U.S., the U.K. side hasn't moved much at all. "The dynamics are very different," said Travers. "The amount of leverage at the borrower level in the U.S. is significantly different than the amount of leverage at the borrower level here."
The U.K. market hasn't reacted in the same way primarily because the interest rate difference isn't an issue here as it is in the U.S., where teaser rates lock in low interest for the first two years. When the interest rate kicks up two years later to a benchmark across the spread, borrowers end up with rate shock, Travers said. Those buyers were counting on refinancing through competing lenders, but the problems in the market mean less opportunity to refinance, which would likely lead to another default increase as borrowers deal with the interest rate hike. "If we do a deal in the U.K., it will be very secured as well," said Travers.
Travers said that FGIC has also tailored back its U.S. subprime focus as well. In late 2005, it began to pull back, completing $7 billion at the end of that year and seeing volumes fall to $1 billion in 2006. Today, FGIC is getting more calls than ever before from subprime players, but the insurance provider has now raised its attachment point to single-A, and it now requires more over-collateralization and excess spread.
For 2007, Travers said that the London team is looking to corporate securitization opportunities. Among the deals, he said, that the team is looking at are the British Aviation Authority restructuring and the Eurotunnel restructuring. He said there is also a football stadium deal that the team is currently looking at. There is also more interest in Central European infrastructure deals, with a number of road projects underway. Basel II is expected to create some buying opportunities. Travers said that some banks may find ways to arbitrage Basel II capital requirements by using monoline product - monoline guarantees are 20% risk-weighted under the new accord.
In Australia, Travers said the London team has found some success and will be opening an office shortly. Last year, FGIC closed three Australian deals using its London-based crew, and the team is working on another five mandates for 2007.
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