Role of Insurance Grows in Global Debt Offerings as Complexity Increases
The notes were issued by a Cayman Islands-based special-purpose vehicle. The issue was a landmark deal in terms of pricing, size and maturity. It was the longest maturity achieved by a Turkish bank. It also was the largest issue for any Turkish financial institution or corporate issuer in the international debt capital markets.
The transaction comprises three portions. A $250 million tranche with a term of seven years was sold at 33 basis points above the London interbank offered rate. A second $250 million tranche with a term of eight years was sold at 36 basis points above Libor. The third part, a $100 million portion with a term of 10 years, was sold at Libor plus 183 basis points.
The first two parts of $250 million each were backed by a financial guaranty issued by MBIA Insurance and Ambac Assurance and had triple-A credit ratings from Moody’s and Standard and Poor’s. The third tranche was unwrapped, or, in other words, not enhanced by insurance, and was rated Baa3 by Moody’s and BBB- by S&P.
The use of financial guarantees and other types of insurance, such as political risk insurance, is becoming increasingly common in corporate debt markets worldwide, as financing deals become more complex.
According to Isbank, the deal will support its balance-sheet growth, improve its maturity profile and allow it to create new asset classes with longer maturities.
“It makes sense that the more-complicated deals use bond insurance,” says Neil Budnick, chairman of the Association of Financial Guaranty Insurers, or AFGI, and president of MBIA Insurance. “First, it simplifies the story for the investor, and second, it parallels how insurance grew in the domestic US market,” he notes. “What will be interesting to see is if the product permeates the total European market as it has in the US,” he says.
AFGI’s 10 member companies are highly rated insurers and reinsurers of bonds and structured asset-backed securities. The total volume of their insured international securities, excluding securities from the US, rose by about 4% in 2004, to $61.2 billion, and is expected to grow substantially in 2005.
“We are strongly bullish about the international prospects for the financial guaranty industry in 2005 and beyond,” Budnick says. International public sector insured volume quadrupled from 1998 to 2003, and asset-backed insured volume tripled in the same period.
At its first international conference in London last month, AFGI released a survey of 74 institutional investors, who forecast that the use of capital markets would increase. Some 83% of those surveyed said they believe public infrastructure volume will increase at least moderately, if not substantially, throughout Europe over the next five years. A similar number forecast moderate to substantial growth in asset-backed transactions in the same period.
According to the survey, Spain topped the list of European countries most likely to experience an increase in public infrastructure or asset-backed securities. Germany was a close second, followed by the UK. France, Italy and Central and Eastern Europe also are expected to experience growth in this area.
The PFI, or private finance initiative, sector is seen as the most likely to expand. Because PFIs are complex, financial guarantees likely will be used to contribute to investor confidence and demand for the securities, Budnick says. “We expect increasing investment in public services, ranging from hospitals to highways, with heightened demand coming from the new member countries of the European Union,” he says.
Pension-reform efforts across Europe are another reason to expect increased demand for financial guaranty insurance, according to survey respondents.
Meanwhile, a growing number of emerging-market issuers are using political risk insurance in cross-border transactions to improve ratings and lower borrowing costs. In late 2003 Banco Bradesco, Brazil’s largest private bank, issued $500 million of 10-year subordinated notes in the US private-placement market. Moody’s Investors Service assigned the notes a Baa1 rating, seven notches above the long-term foreign currency debt rating of Brazil.
A political risk insurance policy issued by Bermuda-based Sovereign Risk Insurance helped the Bradesco issue to break through the sovereign credit ceiling. The issue, which originally was planned for $300 million, was heavily over-subscribed and was increased to $500 million. Merrill Lynch was the sole placement agent for the bonds.
The 10-year political risk insurance policy covers up to 18 months of interest payments on the bonds against the risks of currency inconvertibility and transfer restrictions in the borrower’s home country. Banco Bradeso used the proceeds to boost its lending activities.
Sovereign, a joint venture between ACE Bermuda Insurance and XL Insurance (Bermuda), provides coverage to many major commercial banks against their ability to receive principal and interest repayments due to a wide variety of political and economic risk events, such as exchange controls, transfer restrictions and expropriation or blockage of funds.
In October 2004 Sovereign issued a political risk insurance policy assisting Turkey’s Finans Bank in raising tier-two capital in the international capital markets. The policy supports the issuance of $200 million of 10-year subordinated callable notes by Finans Capital Finance. The 10-year policy covers up to 18 months of interest payments on the notes against the risks of currency inconvertibility and non-transfer. Merrill Lynch acted as sole placement agent.
Alex von Sponeck, head of EEMEA securitization and structured finance at Merrill Lynch International in London, says, “This is a landmark issue for banks in Turkey, and the Finans Bank deal was timed strategically around the EU accession discussion for the Republic of Turkey.” The innovative structure helped the bank achieve its capital-raising objectives at a very competitive pricing level, he says.
Telecom Borrowing is Brisk
In the US high-yield market as well as leveraged loans issuance, telecom was the top industry in 2004. Leveraged loans are syndicated bank loans to non-investment-grade borrowers.
The growth in the issuance of collateralized debt obligations, or CDOs, and collateralized swap obligations, or CSOs, has been phenomenal over the past two years, says Robert McAdie, global head of credit strategy at Barclays Capital in London. There also has been a significant expansion of hedge funds and an expansion of credit proprietary trading desks and arbitrage funds, he says. “Low funding costs and low yield levels have propelled this industry,” he notes.
The growth of the leveraged loan market has also been significant, especially in the US. Although not of the same magnitude, leveraged loan issuance in Europe also has taken off, McAdie says. “We do have concerns as to the performance of some of these deals, especially some of the German and Italian deals, where some of these low-margin companies will struggle in the low-growth, high-wage and high-material cost environment in 2005,” he says.
Overall, the backdrop for credit in 2005 is solid, with low systemic risk, relatively low issuance and strong demand, McAdie says.
Clearly, the growth of hedge funds, funds-of-funds, leveraged loans and CDOs is indicative of the amount of leverage that has been pumped into the system, McAdie says. This is a cause for concern, he explains, because the longer volatility stays low, the larger leverage will grow.
The greater the issuance, the greater the net impact will be on the market once there is any material volatility, he says.