Wrapping paper

Australia's corporate bond markets are as active as ever with a steady flow of infrastructure projects bringing plenty of long-dated paper. MBIA makes it happen by adding a triple-A wrap. FinanceAsia spoke to joint directors of MBIA's Asia Pacific business, Robert Velins and Graham Metcalf, about their business strategy, fears of saturation and the future for Aussie bonds.

What has the downturn in the market meant for your business?

Velins: We operate on a fear and greed index. When greed dominates then investors don't want the insurance that a monoliner provides, they will take the spread even if it has reached an unsustainable levels. When investors are terrified of market conditions then wraps are important, our premiums go up and this is good for our business. We are now somewhere in the middle of this index. Greed was winning a few years ago when there were rapidly declining credit spreads around the world. But recent global events and a major credit crunch have really heightened the value of credit analytics and the importance of the wrap.

And what about the effect of declining interest rates?

Velins: This usually means that we get a reasonable amount of refinancing business and given that we receive a majority of our premium up front, then this is good. In a low interest rate environment borrowers are inclined to borrow longer term and term is certainly one part of our value add.

Fixed income investors are breaking with tradition and investing further down the credit curve in an attempt to beat the index? Does this worry you?

Velins: We would always prefer that there was unwrapped debt competing with wrapped debt. Why? Because we don't want to be the only game in town, and as much as we pride ourselves with a good track record on credit decisions it is nice to have other unwrapped deals out there to act as a benchmark. The presence of clear pricing on an unwrapped risk helps to highlight our value proposition to an issuer. So we don't see any problem with investors becoming more sophisticated about credit risk. It increases the overall appetite for debt.

Metcalf: Investors need the credit skills to analyse the risk on unwrapped paper because MBIA wrapped paper is in reality two name paper. Investors need to determine the probability of default on the underlying assets and multiply it by the probability of default on the AAA wrap to come up with the right calculation of default risk. This should be reflected in both the yield for the asset and in investors credit limits for AAA wrapped paper.

What are the best deals that you have wrapped this year and which ones have you made the right decision to stay away from?

Velins: I think time will prove that the SCAC bonds (issued following the sale of Sydney Airport to Southern Cross) were a good deal. They and the other Australian airports received a fair outcome on regulatory review and they have strong cash flow to service their debt. The Transurban and Gasnet wrapped deals both delivered excellent long term funding to the issuer and were well structured to take account of investor preferences. In the power sector we have stayed away from generation assets because of the market risk. We have generation exposure embedded in integrated utilities and can wrap generators where the risks are mitigated through long term power purchase agreements with strong credits but we have shied away from doing pure generation. This is an impaired asset class in the Australian market at the moment, so our decision has been vindicated.

Why are monoline insurers more active in Australia than any other Asian market?

Velins: Australia has done a relatively good job of structuring its regulatory environment. This means that MBIA has been active in privatisation deals for electricity distribution and transmission companies and also the airports. We do these because we are comfortable with the regulatory environment, from a senior debt perspective.

Can this regulatory environment be replicated in Asia and would that lead to MBIA being more active in the region?

Velins: The Asian countries are all sophisticated in their own right and each of the major markets has its own characteristic way of doing things. We have looked at doing deals in Asia but Asian equity takes a pretty aggressive view on refinancing risk and the bank market is very well bid, so the monoline insurers have a tougher time making a value proposition. In many cases, Asia is also ruled out because for us to offer a financial guarantee the underlying assets have to be investment grade. And in the countries that are investment grade there is plenty of bank liquidity. The biggest opportunity for us would be in Korea where there are some large infrastructure projects under way and the government is encouraging foreign participation in these deals. They want a slice of foreign debt and this is where we can get involved.

What about wrapping securitized deals in the region?

Metcalf: Securitization transactions are popular in parts of Asia and this is where we see some potential. The recent deals have been largely consumer receivable transactions. We are currently working on a significant deal in Korea and last year we wrapped part of a securitisation transaction for Samsung.

The structured market is Australia is dominated by mortgage-backed deals, will this ever change?

Metcalf: We certainly hope so and are optimistic about adding more structured finance transactions to our book of mainly infrastructure deals in this part of the world. A lot of institutions are trying to widen the type of assets that are being securitized. There have been a few equipment leasing transactions and the CMBS sector has made some progress but it remains that about 90% of asset-backed deals are residential mortgage deals. We have the right legal and regulatory system to development the market, we have professionals and issuers in the market who know what they are doing and we have a growing pool of funds under management, so sooner or later we will see some diversification.

Maybe the problem is that the issuers don't need the cash?

Velins: That is one of the problems. The banks are just so well capitalized - they have great retail franchises and produce huge lumps of capital each year.

With four monoline insurers plying for business in Australia, would you say that the market was over-wrapped?

Velins: Our biggest competitors are the banks. But amongst the monolines there is certainly more competition now than there was a year ago. XL Capital is now active in this market from an office in Singapore, and then there is AMBAC and FSA. MBIA has a solid reputation for being pleasant to deal with, executing well, delivering on time and keeping the legal side of the transaction under control. We also have the benefit of scale which means we can bid on the large deals.

How many more deals can you wrap? Do you have any capacity issues?

Metcalf: We have no capacity issues as such at the moment, although there are only a finite number of assets in this country that will meet MBIA's criteria. We have no term issues either so we can wrap long-dated deals. We can go out to 30 years without a problem. The constraint on tenor is driven by what investors will buy not by what we will wrap.

And have investors had enough of MBIA-wrapped paper?

Velins: With 56% of the wrapped market we are not as dominant as some people would make out. Though there has been a lot of supply hitting the market recently and there is some overhang, this is more an indigestion issue than a sign that the market is full.