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Report: Issuers, Create Your Own Enhancer

Municipal issuers should investigate the possibility of creating a national mutual credit-enhancement company, said a new report by an industry commission convened by the National League of Cities.

As a mutual company owned by its members, the new entity could focus on minimizing the cost of borrowing, rather than maximizing profits, said the report, which was released yesterday.

"We believe that a triple-A insurer at reasonable rates would reduce the borrowing costs by providing both comfort as it relates to credit exposure as well as liquidity," said Bob Inzer, chair of the committee and Leon County, Fla.'s clerk of the court.

The National League of Cities convened the 17-member blue-ribbon commission last October to examine the impact the downgrades to insurers were having on the municipal market. The panel also supported changes to federal tax law that could help stimulate investor demand for municipal credits, including expanding the bank-qualified issue limit to $30 million from $10 million and changes to the 2% de minimis rule for financial institutions.

Downgrades to the ratings of bond insurers were among many problems that weighed on muni market issuers last year. Insurance penetration fell to 18.4% from 48% with fewer top-rated insurers in the market.

The commission's report said any study should focus on the prospects of creating a mutual insurance company that would back fixed-rate debt, including general obligation bonds and revenue bonds for essential services. The money to fund such an insurance effort could come from state pension funds, federal support, or a reserve fund paid into by borrowers that use the program. The panel also recommended consulting with the Treasury Department to see if it would be willing provide a guarantee or reinsurance for such a new company.

Market participants said some form of federally supported guarantee program could be an efficient way to help the market.

"The proposal of a national bond bank insurer is actually quite a good one," said Guy LeBas, fixed-income strategist at Janney Montgomery Scott LLC. "It would provide the homogeneous credit the market needs to establish liquidity in municipals. I think it would probably have an across the board impact on the sector."

At least eight pension systems have considered creating credit enhancement programs to back short-term, variable-rate debt, but the process could take between 12 and 18 months to actually start a program, the report said. Other state pension plans have said such programs would be too complex to manage and would provide relatively low returns. None of the pension plans have considered providing support for long-term, fixed-rate issues, the report said.

A new mutual insurance company could help fill the gap and help bring down borrowing costs, according to Inzer. The company would benefit from not having the pressure from shareholders and others to expand into riskier products to generate higher returns.

"From a business model, what drove the traditional insurers to look for that was basically seeking yields and return," he said. "To the extent that this is a mutual company, you're not going to be under those pressures."

Any plans are still in their early stages and there is a "significant amount of additional work that needs to be done," Inzer said. There are still questions about how to raise capital, how the mutual company would actually provide credit enhancement, and how to ensure it would operate independently - removing any politics from the process of deciding what credits to back.

The report referenced a number of other public credit-enhancement solutions. The Texas Permanent School Fund guarantees Texas school issues, but has reached a capacity constraint, keeping it from backing new debt. The California State Teachers' Retirement System and California Public Employees' Retirement System have provided letters of credit in the short-term, variable-rate market.

Since the deterioration began last year, new municipal bond insurers have launched, including Berkshire Hathaway Assurance Co. and Municipal and Infrastructure Assurance Corp., the latter of which is still in the process of getting ratings and obtaining licenses. In addition, bond insurer parents Ambac Financial Group Inc. and MBIA Inc. are seeking assistance from the Treasury Department's Troubled Asset Relief Program.


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