10.17 Some of the drawbacks of a bond such as investors pricing uncertainty and bond deliverability can be mitigated through the use of a monoline insurer to "credit enhance" or "wrap" the bond. A monoline insurer is an insurance company rated AAA by the rating agencies, whose sole business is to guarantee the payment of bonds and other debt. By adding its guarantee i.e. "wrapping" the bond, the bond will be rated AAA, the highest rating achievable.
10.18 "Wrapping" project related bonds is forming an increasing part of the monoline's business. The monoline will undertake a due diligence exercise similar to that undertaken by banks to decide whether it is satisfied with the underlying risk of the project. It will require the bond to be rated at least investment grade by the rating agencies.
10.19 The monoline insurer charges a fee for its guarantee, which is the equivalent of a bank's credit margin. To build on the above example:
10-year gilt |
The guarantee fee, unlike credit margins, can be payable in a lump-sum up front with considerable cash-flow implications. The movement on AAA paper is less than that for lower rated paper, thus pricing a wrapped bond is less unpredictable but still not without market risk. Often the guarantee fee will be part paid upfront and part paid over time.
10.20 If an unwrapped bond is being used there are 3 points which should be contemplated:
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1 Subject to market fluctuations and reflecting the investors' appetite for AAA paper
2 Margin required by monoline based on its assessment of risks in the project