best debt deals, The

Global Finance, Feb 1999 by McTigue, E Guthrie

The company intends to expand its milk business in emerging markets, particularly China and India, and wanted to develop a way of raising debt capital that would free it from dependence on Italian commercial banks. The cumulative preference shares, the first for a European company, are carried on the equity side of the balance sheet but pay a quarterly dividend priced like an interest rate and payable before the common dividend. Moreover, though the paper is nominally perpetual, like common stock, it does not dilute shareholders' equity. It was structured with a put option allowing investors to redeem at 20 years-thus making it, in effect, a 20-year debt instrument.

Merrill sold three tranches in December 1997, then followed up last June with two more. Together, the five tranches raised $519 million.The first three were denominated in Italian lire ($89 million), British pounds ($169 million), and US dollars ($100 million). The June tranches were an ecu issue that has now turned into a euro issue ($139 million), plus an add-on $28 million in lire-denominated shares.The sterling tranche carried a fixed dividend rate of 9.375%, while the other tranches carried floating rates of 2.25% over three-month Libor in lire, dollars, and euros.

Most of the buyers were insurers and pension funds. The paper was so confusing that many investors called them "notes." One investor just called them "things."

5 National Provident's securitization

It was a small deal, but its implications for the insurance industry are profound. Last April National Provident Institution, Britain's fifth-- largest mutual life insurer (which is now being demutualized) freed up 260 million ($430 million) of reserves with bonds backed by future revenues from life insurance policies and pension contracts.

The property and casualty industry began experimenting about 15 months ago with catastrophe bonds based on such huge risks as earthquakes and hurricanes.The NPI deal is the first to turn ordinary life policies and pensions into securities. Over the coming decade, more and more insurance risks are likely to be transferred to capital markets, a "disintermediation" (similar to what happened to the US banking industry- in the 19?Os and 1980s) that directly threatens the world's reinsurers.

The deal was done through a special-purpose vehicle called Mutual Securitization, registered in Ireland, and was sold in two tranches. One, for L140 million, carries a 7.39% coupon and will be paid off over 14 years; the other, for 120 million, carries a 7.59% coupon and matures in 24 years-the first time such a securitization has gone beyond five years.

Structured and managed by Warburg Dillon Read, it was somewhat modeled after efforts to securitize US mutual fund fees. The income stream is investment management fees of 0.75-1.0%. Fees, however, are based on performance, so there's a danger that the portfolio, invested mostly in stocks, might not perform adequately. There are, however, two safeguards: The deal is overcollateralized to the tune of two times debt coverage, and a L40 million backup fund can help cover payments of principal. It was rated A- by Standard & Poor's and A3 by Moody's. -E. Guthrie McTigue