NAIC Offers Alternate Ratings For Some Insured Muni Bonds

A group of state insurance regulators is beginning to provide substitute credit ratings for municipal bonds held by insurance companies and is pitching the ratings to financial advisers and other market participants as a way to improve the marketability of issuers’ bonds to these companies.

In letters to market participants last week, the National Association of Insurance Commissioners said that during the past three months its securities valuation office has provided “credit designations” to more than 200 munis held by mostly property and casualty insurance companies, which are incentivized under the tax code to buy munis.

“Insurance company portfolio managers have long regarded NAIC ratings as well thought out, credible, and dependable,” NAIC said in one letter, which was signed by Chris Evangel, managing director of its securities valuation office. “The advance knowledge of an NAIC credit designation by insurance companies regarding your clients’ primary market bond offering can only serve to broaden and deepen the market for your client’s municipal securities. This can expand the universe of issuers with underlying ratings, which should facilitate the marketing of municipal debt issues to the insurance companies.”

The letters come after NAIC announced in June 2008 that it would take action to provide its designations for municipal bonds because many of the ones insured by monoline insurance companies had their ratings withdrawn after the insurers’ ratings were downgraded to junk status. As a result, the property and casualty insurance companies holding these bonds had no underlying ratings to fall back on for the bonds they were holding.

The downgrades were problematic because at the end of each year, insurance companies are required to perform risk-based capital assessments on the credit quality of the securities they hold. Without a higher underlying rating, an Ambac Assurance Corp.-wrapped bond would be rated triple-C and would have a 30% capital charge.

In other words, for every $1,000,000 of Ambac-backed bonds, these insurance companies would have to hold $300,000 in reserve capital.

But by applying NAIC’s credit designations, which focus on the underlying credits,, insurance companies holding muni debt designated as investment grade would have capital charges of 1% or less, regardless of whether it had been insured by a monoline company whose rating had been ­downgraded.

Of the 214 muni deals NAIC has rated in the past three months, about 100 were Ambac-backed deals, while the rest were rated by other insurers or were unrated, according to NAIC officials.

While NAIC has provided numerical rating designations for bonds since 1947, prior to 2008 it was unable to provide designations that were higher than the ratings provided by a credit rating agency. Under a proposal adopted by the regulatory group two years ago, NAIC decoupled the NAIC rating from the rating agency process. NAIC’s designations are based on a numerical rating scale of 1 to 6. Munis rated “1” or “2” are considered investment grade, with “1” equivalent to A-minus, A3, or better, while “2” is equivalent to triple-B. Meanwhile, ratings 3 through 6 are considered below investment grade, with a “6” considered a near default bond.

Collectively, the insurance industry holds about $443 billion of municipal debt, according to NAIC.

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Washington
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