Insurers Approach Technology Creatively To Enhance Both New and Old Businesses
Three bond insurers are creatively exploiting existing technologies to either enhance their tried and true municipal bond guarantee business or establish new beachheads in public finance.
AMBAC Indemnity Corp. is employing an in-house computer program that binds the various underwriting disciplines into one. The system, which puts all current underwriting data into a single repository, allows both public officials and insurance underwriters to get updated information on the status of each deal and their colleagues' opinions.
Municipal Bond Investors Assurance Corp. has launched a new cash management service that devotes the most advanced portfolio techniques, within limits, to municipal borrowers.
And Capital Guaranty Insurance Co. is using the facsimile machine and a simple surety bond to get nationwide advertising, which underwriters actually pay for.
Capital Guaranty last year realized that an annoying and antiquated market practice - the "good faith" deposit check - could be swept away and a subtle marketing tool implemented if the insurer were to assume the responsibilities involved.
Issuers typically require underwriting candidates to deposit with a trustee 1% to 2% of the par amount being sold prior to a competitive bond offering. Bank checks are hurried over by hand to the respective banks, often within hours of the deadline and occasionally too late for consideration.
The new Capital Guaranty method obviates this municipal Pony Express holdover with the use of a facsimile machine. The bond insurer deposits a surety bond with the trustee, guaranteeing the issuer funds from all dealers and underwriters who want to participate.
Behold the Fax
As more underwriters sign on by faxing a form to Capital Guaranty, Capital Guaranty faxes an updated list of qualified bidders to the issuer's financial adviser. In a flash, an underwriter is in the running for a deal that might have slipped through the cracks.
The program, titled "Sure-Bid," has grown impressively since its inception March 1. As of early last week, 218 competitive issues have included bids from the Sure-Bid program, and 88 of those deals were won by participants using the Capital Guaranty program.
The surety bond - a guarantee to the issuer that the winning bidder will commit funds to the deal - is also a clever method of automatic advertising, according to Michael F. Gallagher, senior vice president at Capital Guaranty. Underwriters are charged only $20 to $50 per bid, too little to declare Sure-Bid a profit center, he said.
"It's never going to make a lot of money," Mr. Gallagher said, "but it does get our name out to various bidders across the country. As long as we provide a great service, some of this is going to translate into [insurance] business for Capital Guaranty."
For financial advisers, the system is quite simple. They take faxed bids from underwriters and record them along with the traditional, hand-delivered good-faith deposit bids. If a Sure-Bid underwriter wins, it then wires the required funds to the custodial bank.
"It has allowed us to bid on things in the last minute, where before I couldn't do that," said Quantella M. Anderson, associate vice president of municipal underwriting at Dain Bosworth Inc. Dain Bosworth now bids on more issues than it did in the past, Ms. Anderson said, and wins about one out of five.
Capital Guaranty also smooths the way for underwriters. After setting up a reimbursement agreement with the bidder, the bond insurer sends out a weekly calendar of issues with all the Sure-Bid qualified deals. Bidders are also supplied with a prepared request form.
"All they have to fill out is the name of the deal," Mr. Gallagher said. "Then they fax it to us, and we fax to them a confirmation."
The initial launch of Sure-Bid was made possible through a cooperative arrangement with St. Paul, Minn.-based Springsted Inc., which is financial adviser on more municipal issuers than any other firm. Through mid-September, Springsted was ranked number one in issues advised for both the overall and competitive categories, according to Securities Data Co./Bond Buyer.
Capital Guaranty brought the concept to Springsted and asked for the firm's advice and opinions on how to implement it, according to Corliss Weeks, vice president at Springsted. "The Sure-Bid idea is a very good one," Ms. Weeks said. "It gives you the best of both worlds: Security for the issuer and it helps the underwriter.
No Muss, No Fuss
"Underwriters wonder why it hasn't happened sooner," Ms. Weeks added.
Most of the participants have been out-of-town bond dealers who make last-minute decision to compete for an issue, Ms. Weeks said. The only reason more bidders have not used the program is that in-house counsel must review the surety bond to see whether the commitment being made fits company policy.
"It's taking a while to get the whole thing worked through their legal departments," she said.
Scott Nash, vice president at Howarth & Associates, a Las Vegas financial adviser that has used Sure-Bid extensively, said the "flexibility" afforded by Capital Guaranty's program is what bidders acclaim most, and he agreed that more dealers await only the go-ahead from their lawyers.
"Some firms haven't approved it yet in their internal policy," Mr. Nash said. "But it really is a good idea. An underwriter can bid with as little as an hour's notice, and it saves the firm paperwork too. There's no check to return."
Ms. Anderson of Dain Bosworth said, "It wasn't so much paperwork. Someone had to walk several blocks and pick up the check at a different bank, so a certain time frame was involved. We didn't have a lot of paperwork, it's just that this is a crazy process."
Capital Guaranty infers in its promotional material that Sure-Bid will actually save the issuer money. The theory is that by facilitating more bids, the chances that a lower-priced offer - saving the issuer borrowing costs - will be received are increased.
Market participants, however, are hesitant to confirm such claims. "Winning the bid has nothing to do with Sure-Bid," Ms. Anderson said.
"We haven't attempted to do anything like a cost analysis or cost effectiveness study," Ms. Weeks of Springsted said. "We look at this more as an inducement for the underwriters to bid and never looked at it as a savings."
Mr. Nash of Howarth said the primary concern of bidders was to make sure the program contained no risks. "Usually, when they find out Capital Guaranty is behind it, they don't get concerned," he said. Most of Howarth's deals involve West Coast bidders, Mr. Nash added.
One issuer, however, said nominal savings are turning up in reduced "float" and labor expenses. Aurora Castellas, manager of bonds and investments in the Los Angeles Department of Water and Power, said it is unlikely lower bids are coming in thanks to the program, but efficiency gains are real savings.
"Having the wire transfer the same day is the best feature on this," Ms. Castellas said. "Also, if we have three checks to return, it takes us all afternoon because we have to Federal Express two to New York and hand deliver the third locally."
Last month, the Department sold a $150 million issue that attracted four bidders, four of which used Sure-Bid while the fourth, Prudential Securities Inc., used a good faith check from a local office. In August, two of the Department's four bidders used Sure-Bid.
The arrival of Sure-Bid has led some industry participants to question the validity and appropriateness of the good-faith deposit in this modern era of instantaneous wiring abilities and interwoven financial networks. The financial advisers, however, maintained that some sort of security is necessary and is unlikely to be eradicated completely.
"Personally, I think there's still a place for it," Mr. Nash said. "It might theoretically be in [a bidder's] interest to walk away from a deal. So it always gives the elected official comfort to say, ~We have a $600,000 check, they are not going to walk.'"
Ms. Weeks pointed out that removing the cumbersome practice would involve a substantial legislative effort that may not be worth the grief. "In a lot of states, [the good faith deposit check] is statutory," she said. "And it still gives the issuer a sense of security that they will go forward and close the deal."
The Sure-Bid concept is certainly not new. Other firms have tried to do away with the good faith check restrictions in one way or another for years. And in Texas, First City Bank of Houston has been providing virtually the same service to instate bidders for almost 18 years.
First City, furthermore, offers the program free to underwriters, considering it part of their usual services provided, according to Gary Peese, senior vice president with the bank.
"It's a global check with a list of approved participants," Mr. Peese said. "We've had many many calls wanting to know about the program" after Capital Guaranty launched Sure-Bid.
Jack E. Addams, director and regional manager in Merrill Lynch & Co.'s Dallas office, said the good-faith market is already spoken for. "There's no reason to use [Sure-Bid] in Texas," Mr. Addams said. "First City Bank supplies a single deposit check at no charge.
"Merrill has agreed to use [Sure-Bid] where it makes sense," he added. "It makes sense, but it doesn't apply down here."
MBIA has taken the most sophisticated short-term money management techniques, added some creative legislative thinking, and come up with a cash-management service for municipal issuers that is spreading throughout the Northeast.
Last January, MBIA announced it had purchased the nascent cash-management business from Bear Stearns & Co. and that it intended to provide a new service to small and mid-sized issuers. For a nominal fee, MBIA takes the cash from the town, puts it in a pool with money from other municipalities in the same state, and lets professional money manager Gabelli O'Connor Fixed Income Management Co. work its magic.
MBIA inherited about $75 million of municipal accounts from 22 New York municipalities when it bought the program. In less than 10 months, the firm has boosted that to almost $200 million of business from 35 New York communities and 11 new participants in Connecticut.
An Awfully Big Prize
And MBIA has its eyes on an awfully big prize. Leon J. Karvelis Jr., who left MBIA proper as executive vice president to become president of the new cash management subsidiary - MBIA Municipal Investors Service Corp. - sees an expanding horizon.
"We have 11 of the 169 towns and cities in Connecticut," Mr. Karvelis said. "I believe there's between $35 billion and $40 billion of cash in the state. Some of that's in state and other programs, but if we get just 10% of that, we'd be very pleased indeed.
"We should be in 15 to 20 states in five years," he added.
The cash management program, called CLASS, offers public officials consistent returns on their idle money that otherwise would be difficult to achieve on their own. At the same time, the pools are invested solely in Treasuries and Treasury repurchase agreements, ensuring both safety and liquidity.
The technology employed is the most up-to-date trading screens; the strategy is simply "plain, simple hard work," said Tom O'Connor, managing partner at Gabelli O'Connor. "We have all the machines."
The firm also has from $1.05 billion to $1.1 billion under management, about $100 million of which is in tax-exempts. Nearly all of the firm's clients are institutions and high net worth investors; the minimum investment in Gabelli O'Connor's institutional money market funds is $100,000.
"Our gambit is to try to take the highest quality securities into active management and eke out an incremental yield," Mr. O'Connor said. In the CLASS program, "we restrict ourselves to a one-year maximum and a 120-day weighted average maturity. I refer to it as a little drop of water here, a little grain of sand there."
Gabelli O'Connor's management strategies, though conservative, result in returns superior to most investment options available to municipalities. Typically, local polities invest in certificates of deposit, state investment pools, demand deposit accounts, or even passbook savings accounts.
From January through August, CLASS returned an average 6.23% to the participating municipalities. The 40-basis-point fee, which covers all program charges - custodial bank fees, record keeping, wire charges, and so on - is netted out of the total return. For the eight months, therefore, CLASS paid itself from a 6.63% return.
"In effect, there's no fee to the municipality," said Francie Heller, executive vice president of CLASS. Ms. Heller founded the service at Bear Stearns and joined MBIA when the insurer purchased it.
In fact, the municipality can look upon the program as a distinct revenue source. Robert Celente, assistant superintendent for business in the Peekskill, N.Y., School District, said the CLASS program is directly responsible for $45,000 in additional revenues to the district. Peekskill has been with the program since Bear Stearns launched it in September 1989.
"We use it almost like a money market account," Mr. Celente said. "We set up different accounts for each of our separate programs, and it all works within CLASS."
The other major strength, he said, is the security afforded by Treasury-only investing: "It doesn't do me any good to get $5,000 return if I can lose $3 million on the downside."
Judy Doneiko, finance director for Plainville, Conn., said the security aspect of the CLASS program was its best feature. Participating since June, Ms. Doneiko expressed relief that a an alternative to New England banks is now available for short-term deposits.
"Given what's happened in the New England banking industry," Ms. Doneiko said, "safety is the most important thing. The Bank of New England a few years ago was deemed very strong. Who knows?
"If we have an investment loss, either we have to cut services or raise taxes," she added.
Beyond the matching of up-to-date trading techniques with less sophisticated municipalities, CLASS needed creative legislative thinking to get off the ground. Ms. Heller, in the early days of the program, realized that New York State's laws were conducive to pools of managed money, if only the municipalities would merge for the stated purpose.
"They can do together, cooperatively, what they can't do alone." Ms. Heller said. "Municipal Law 1190 allows municipalities to join together for insurance services, snow removal, etc. We realized the cooperative investment concept is also legal for municipalities in New York."
She added that State Comptroller Edward V. Regan's Opinion 8846 clarifies this municipal ability.
A minor snag in New York's local laws is that the new "cooperative" must sign off on Gabelli O'Connor's trading decisions. This, too, has been smoothed out through appointing a representative of the communities' board of directors, whom Mr. O'Connor contacts for routine approval.
The success of the program is partly dependent on word-of-mouth advertising passed along from municipal official to municipal official. It's no mistake, Ms. Heller said, that towns in Western and central Connecticut were the next batch of CLASS participants after the pioneering New York municipalities.
"The municipal fraternity is actually pretty small," she said. "They attend the same meetings, meet at the same conferences."
Mr. Karvelis added that regional participation makes sense in the program's early stages because MBIA, headquartered in Armonk, N.Y., is close enough to be reassuring. In fact, the bond insurer is building a 60,000-square-foot auditorium on the Armonk site for the CLASS participants' quarterly meetings.
One final incentive for MBIA, Mr. Karvelis said, rests in the mutually beneficial goal of sound financial management. An issuer using MBIA bond insurance is that much better known if its cash is also under MBIA's care.
"It's somewhat self-protective," Mr. Karvelis said. "Before, if there was the possibility of losses, [a municipality] may have defaulted on its insured bonds and we'd have to pick it up on the insurance side."
AMBAC's computer program is particularly suited to the insurer's system of underwriting municipal credits. The single repository of information allows analysts to review other disciplines and "cross-pollination" to take place.
Unlike the other firms where different departments are responsible for a credit at different times - one group handling new business solicitation, another doing the underwriting, and still another providing ongoing surveillance - AMBAC assigns an analyst to live with his or her credit. The same person, for example, both underwrites and monitors an insured bond.
The computer system, first installed in January 1990, is similar to the vaunted Federal Express service of locating a package at any point, from origin to destination. Public officials looking for the status of their borrowing can call virtually any analyst and obtain all the information gathered and observed to date.
"It helps the issuers quite a bit, said P.K. Vichari, senior vice president and director of information management group at AMBAC. "Now they can call anybody and get on the system. Before that, whoever got the call had to chase the paper and chase the deal."
Mr. Vichari described seven loose underwriting stages that issues must pass through before being finalized. Issuers can follow the progress from issue review to AMBAC's qualification and committal, through closing, post-closing, data entry, and rating agency follow-up.
Reining in Overhead
Although the system - dubbed MATRIX, for Municipal Analysis Tracking and Information Exchange - removes the "people-dependent" aspect of issuer inquiries, Mr. Vichari said, it has not resulted in a reduction of AMBAC's work force.
"Actually, it has allowed us to do many more deals - with the same people - than what we have been able to do without it," he said. "All the commitments go directly out of the system."
None of the other bond insurers use AMBAC's type of deal-tracking set-up, according to Mr. Vichari. The idea came from the property/casualty insurance sector, where a similar single-repository computer program is used for certain commercial lines, such as automobile insurance, he said.
Prior to joining AMBAC, Mr. Vichari was with Citibank as a vice president in technology and operations, and before then he spent ten years with Continental Corp., where he encountered the deal-tracking system.
As described, the MATRIX arrangement allows many monitoring functions to be completed in the "front-office," or by those officials working directly with clients. Once AMBAC's seven-step underwriting process is completed, the data is transferred for subsequent surveillance to a back-office system, which all the other insurers deploy.
But MATRIX also enables the bond insurer to assign a calendar of noteworthy events - a series alarm bells - to each deal prior to being sent to the back-office monitoring. Review dates, based on anticipated debt service draw downs, changes in bond structure, first call, and so on, are thus automatically called to the analysts' attention.
"It has a time schedule so that three to four months before [the review date], the operations department can assemble the proper documents, then provide all the pertinent information to the underwriter."
With premium rates settling into low although adequate troughs, bond insurers are bound to look to reducing in-house expenses to keep up profitability. AMBAC's achievement of increasing business while keeping personnel static is a prime example. In another example, MBIA officials have described surveillance as a "profit-center," in that losses avoided may as well be profits.