Sell Side

Insurance Woes Persist

Insurance penetration has fallen to new lows in the month since Moody's Investors Service placed triple-A insurers Assured Guaranty Corp. and Financial Security Assurance Inc. on review for downgrade.

About 6.2% of new issues have come to the market insured since the announcement July 21, compared to 20.9% year to date, according to Thomson Reuters data. As a result of the announcement, both companies have taken steps to try to reassure the market about their stability.

"The Moody's action has created a lot of uncertainty in the market, and a lot of market participants and investors are sort of waiting to see what Moody's final commentary is going to be," said Bill Hogan, senior managing director of public finance at Assured. "We're very confident in the strength of our company. I think when the dust settles, we expect to see a lot more interest and appetite in our product."

Moody's placed both companies on review for downgrade last month, citing problems for the financial guaranty industry as a whole and concerns with each company. Although Assured exceeded triple-A capital adequacy requirements, Moody's took issue with the insurer's concentration of exposures to corporate collateralized debt obligations.

Much of that debt, as Assured notes, receives high ratings from Moody's itself. FSA, on the other hand, fell below Moody's requirements at the time of the announcement, and has significant exposure to direct residential mortgage-backed securities and to Jefferson County, Ala., the rating agency said.

Jefferson County, which has some $3.2 billion in debt outstanding for its sewer system, is considering filing for bankruptcy protection perhaps as early as this week.

Moody's said it will issue its decisions on both companies' ratings by early next month, but both companies have sought to reassure the market in the meantime. Unlike downgraded insurers, both have continued to write new business in spite of the turmoil.

Through Monday, Assured has wrapped $1.44 billion on 76 new issues since Moody's announcement, while FSA has wrapped $651.2 million on 41 new issues, according to Thomson Reuters data. A total of $247.5 billion new issues have come to the market during that time.

Assured has touted its capital adequacy in discussions with issuers, underwriters, and investors, and released details of its structured finance portfolio on its Web site. To promote some of its recent deals - such as its backing of $350 million of fixed-rate bonds for the New Jersey Higher Education Student Assistance Authority -the company has stepped up its advertising efforts and sent out press releases. It recently reported a second quarter operating income of $ 38.7 million at a time when profits have eluded many financial companies.

"There clearly has been an impact, it's been obviously negative - you wouldn't expect it to be positive - but also, if you look at those volumes compared to what we were doing nine months ago, they're still a lot higher," Assured Guaranty president Michael Schozer said. "It's kind of hard to judge impact because we're in the middle of August, but it's also pretty easy to see we're still writing new business."

FSA limited its bidding on deals following the Moody's announcement until its parent company, Financial Security Assurance Holdings Ltd., released its second quarter financials on Aug. 6. That day, FSA Holdings said it would receive a $300 million capital injection from parent Dexia SA, which would also take responsibility for the liquidity and investment risk of the investment portfolio of its financial products company. In addition, FSA announced it would stop writing structured business and focus solely on public finance.

"We have been actively communicating and believe that the market has appreciated our transparency," FSA president Sean McCarthy said in a statement. "Though the market has been fairly quiet, we have guaranteed a number of deals and are hard at work. We continue to work closely with the rating agencies to reestablish our triple-A stable ratings."

Both FSA and Assured are rated triple-A with a stable outlook by Fitch Ratings. Standard & Poor's rates both triple-A, with a stable outlook for Assured, and a negative outlook for FSA.

The threat of downgrades by Moody's has the market jittery. Secondary market trading spreads between the remaining triple-A insurers have widened when they had historically traded in unison. Some traders have even reported paper backed by Assured and FSA trading through to the underlying rating.

"Institutions are favoring double-A or better paper without bond insurance, often shunning even the three triple-A rated insurers," wrote Citi's fixed-income strategist and managing director George Friedlander in a recent report. "Virtually everything else is left for the household sector to absorb."

Joe Darcy, a senior portfolio manager at Dreyfus Corp., said his company always viewed insurance as an enhancement, rather than a substitute, to credit. A well-informed investor will examine an underlying credit anyway, and might prefer to have the "full yield compensation for the risk that I'm being exposed to," reducing his desire for insurance, he said.

But he said that there will always be investors in the market that want insurance, as long as the companies can provide it.

"There's always going to be an investor out there that wants to have the safety blanket around them," Darcy said. "And to the extent that the insurers are able to conduct their business in a prudent and sound manner and maintain triple-A ratings, they will have a product that fits into that mindset."

Still, the uncertainty in the market has minimized the value of insurance, some issuers say. Following Moody's announcement July 22, a number of issues set to come to the market backed by FSA or Assured priced without insurance. The Rhode Island Health & Educational Building Corp., for instance, planned to use FSA to wrap $24.7 million in bonds it priced July 30, but chose to issue them uninsured instead.

"Our financial adviser and senior underwriter on the transaction basically ... came to the conclusion that there was no value to insurance and quite frankly it may have been somewhat detrimental given the uncertainty," executive director Robert Donovan said. "We saw no value plus we ended up not paying the premium. It purely came down to economics."

Other issuers said they still see value in insurance, though. Spreads on lower quality credits remain wide and even top-rated small issuers can use to the boost insurance can provide.

Assured has focused its recent efforts on issues aimed toward retail investors, such as those from small issuers and bonds sold in competitive deals. It recently backed $33.7 million in certificates of participation in a negotiated sale for Wilson, N.C., a 44,000-person city in the eastern half of the state. Although it considered entering the market uninsured, the city ultimately decided paying the premium was worth it.

"It basically came down to that [the underwriter's] desk thought investors were still valuing them," said Gordon Baker, the city's chief financial officer. "The group decided that it made sense. It was the usual economic decision."

The impact of potential new entrants in the insurance market, shifts to global rating scales, and investor demand will continue to weigh on the long-term uncertainty for insurance in the municipal market. In the short-term, though, market participants say the use of insurance will be based largely on the day-to-day news of the insurers, such as Moody's eventual decision.

"I think it's going to fluctuate with the news, because the decision to insure depends on instantaneous investor appetite for any insurer," said Matt Fabian, managing director at Municipal Market Advisors. "As the news looks volatile, and investors in the muni-sector they tend toward being optimistic about the insurers. They want to believe the best."


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