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Assured/FSA: Last One Standing

OCT 15, 2009 7:49pm ET
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Assured/FSA is the only player in the game.

The rest of the bond insurance industry is either insolvent, politicking for ratings from the rating agencies, or taking their ball and going home.

Assured Guaranty and Financial Security Assurance combined to insure $2.41 billion of municipal bonds in September. That is the only business anyone wrote during the month.

In fact, Assured and FSA have underwritten the insurance for just about all of the $29.96 billion in insured municipal bonds through the end of September, according to Thomson Reuters.

Assured/FSA wrote insurance on $8.7 billion of municipal bonds in the third quarter, which is 9.6% of the total issuance for the period.

The only other guarantor on the board for the year is Warren Buffett’s Berkshire Hathaway Assurance, which covered $583.3 million of municipal bonds earlier this year but has not insured any deals since April 16, according to Thomson.

That leaves essentially a 100% market share for Assured and FSA.

The company, in its current form, was created in July through a merger of the two biggest remaining active bond insurers.

Assured and FSA continue to operate as separate underwriters under the same parent company.

In responding to a downgrade by Fitch Ratings earlier this week, Assured/FSA said municipalities’ demand for the company’s insurance remains robust. The company has insured 10.3% of the $283.94 billion of municipal debt sold as of the end of September.

“Our market activity for the first nine months of 2009 demonstrates the demand for bond insurance,” Bill Hogan, senior managing director for Assured/FSA’s public finance business, said in a release on the company’s business for the third quarter.

While Hogan said the company is writing insurance for “a broad range of issuers, both large and small,” the numbers suggest Assured and FSA are insuring more small deals.

This time last year, the average dollar size of a deal insured by Assured or FSA was $29.6 million. This year, the average is $17.9 million.

Assured and FSA are dominating a market that only two years ago had seven viable players.

The housing market collapse and the worst downturn since the Great Depression have brutalized the financial strength of MBIA Insurance Corp. and Ambac Assurance Corp., as well as many of the smaller carriers such as Syncora, CIFG, and FGIC.

MBIA’s new affiliate, National Public Finance Guarantee Corp., is awaiting the outcome of litigation.

A new bond insurer, MIAC, is still awaiting financial strength ratings.

The devastation of many of the top insurers’ ratings has reshaped not only the bond insurance industry but the municipal market itself.

In 2007, issuers sold $201 billion of insured bonds, representing half of the market. This year, municipalities are on pace to sell just $40 billion, and insurance penetration — meaning the percentage of new bonds that are insured — is 11%.

Downgrades have also eaten into sales of letters of credit, which are used to support issuance of variable-rate debt.

Variable-rate debt carries an interest rate that resets regularly. In order to be eligible for purchase by money market funds, most variable-rate debt needs a guarantee from a highly rated bank.

This time last year, banks had sold municipalities $57.91 billion of letters of credit. The liquidity crisis hobbled many banks’ credit ratings, shoving many of them out of the market for writing LOCs for variable-rate debt.

As a result, fewer banks are offering the product, making letters of credit more expensive and difficult to find.

So far this year, municipalities have sold just $24.03 billion of variable-rate debt.

“Because it’s been such a hassle to find banks with letter of credit capacity, issuers and underwriters are choosing to do more fixed-rate debt than they would otherwise do,” said Rich Raffetto, head of government banking at US Bank. “Issuers are voting with their feet by avoiding the variable-rate demand note market altogether.”

US Bank slipped to second place in letters of credit in as of the end of September, behind JPMorgan. JPMorgan has sold $2.64 billion of letters of credit this year, compared with US Bank’s $2.55 billion.

SunTrust Bank and Bank of America-Merrill Lynch became more active in the market in September.

Orrick Herrington & Sutcliffe remained the top law firm advising municipalities on bond sales, serving as bond counsel on $39.87 billion of deals so far this year. Hawkins Delafied & Wood is second, with $18.38 billion. Hawkins is first for advising underwriters, with $11.89 billion in deals. Orrick is second with $10.3 billion.

Bank of New York Mellon retained the top spot among trustees of municipal bonds, serving as trustee for $65.84 billion of deals with a 42% market share through the first nine months of the year.

US Bank remained in the second slot, acting as trustee on $41.24 billion in deals for a 26.3% market share. Wells Fargo retained the third spot and Deutsche Bank remained in fourth.

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A recent phenomenon is the emergence of bonds with shorter call protection as funding alternatives for municipalities. However, the shorter call protection also dampens the potential upside for investors, which in turn reduces the price they are willing to pay.

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