Credit enhancement or credit wrapping is a technique for reducing investor's cost of debt for a PPP project. The underlying credit rating of most Australian PPP projects is BBB (Standard and Poor's 2004, 2005). Credit wrapping is essentially a AAA guarantee of the borrowing consortium's debt purchased for a fee which is less than the difference in borrowing costs between the two rating standards. This can be significant over the life of a PPP with the spread of 5 year corporate bond swap rates at 30 June 2008 standing at 159 basis points (1.59% pa) for BBB and 106 basis points for AA (RBA 2008). At 30 September, the spreads were 251 basis points and 135 basis points respectively. The monoline insurer guarantees against default in the payment of both bond interest and principal.
Table 4 Credit Insurance Market, Australia, 2007-08
| Market Share % | Rating | ||||
| 2007 | 2008 | ||||
| S&P | Moody's | Fitch | |||
| MBIA | 37 | AAA | AA | A2 | |
| Ambac | 25 | AAA | AA | Aa3 | |
| FSA | 17 | AAA | AAA | Aaa | AAA |
| FGIC | 11 | AAA | BB | B1 | CCC |
| XL/Suncora | 9 | AAA | BBB- | B2 | CCC |
| Assured | 1 | AAA | AAA | Aaa | AAA |
SOURCE RBA August 2008
Most PPP projects in Australia are highly leveraged, debt is generally raised by the issue of rated bonds and the project's (underlying) credit rating is calculated by reference to the credit characteristics of the PPP deal and this includes the track record and credit strength of the consortia members as a measure the principal contractor's capacity to complete delivery of the project. In Australia, few of these companies are rated above investment grade (BBB). Borrowings costs are correlated with risk reflected in credit ratings. In the past 12 months, spreads have increased. Consortia issue bonds and these are credit-wrapped by AAA rated intermediators and rated by credit agencies. The effect is to reduce the cost of debt and extend maturities.7
In June 2007, the Australian credit-wrapped bond market stood at $27 billion, accounting for around 7% of the domestic non-government bond market (RBA 2008). This market has increased dramatically in size in recent years, doubling since 2004 largely as a result of strong growth in the number of motorway PPP projects commissioned in this period. In June 2007, over 60% of this market was shared by two institutions - MBIA and Ambac (see Table 4). At that date, the guarantees of all 6 firms in this market were rated Standard and Poor's AAA. In August 2008, only 2 of the firms retained their AAA status with MBIA and Ambac re-rated to AA and FGIC and XL/Syncora re-rated to BB and BBB-respectively. The rating downgrades are reflected in increased margins between credit wrapped bonds and other non-government unsecured AAA-rated bonds in the secondary market. Average margins increased from an average 25 basis points (0.25% pa) in July 2007 to 130 basis points (1.3% pa) in July and 240 basis points (2.4% pa) in November 2008.
The recent revised agency for credit insurers followed a general repricing of risk on international and domestic capital markets and will impact both the cost and availability of future debt raisings and financial risk management tools for PPP projects.
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7 The definitions of credit ratings AAA, AA, BBB and BB are set out in under Abbreviations.