It’s been a rough few weeks for the stock market and an even worse period for the stocks of municipal bond insurers.
Since April 23, Assured Guaranty Ltd., the only guarantor continuing to underwrite new issues, lost 40.7%, or $10.03, of its stock market value.
Last week it dipped as low as $12.68, its lowest price since last July. It closed Friday at $14.59.
MBIA Inc. — which hasn’t written new insurance since 2008 but maintains the largest municipal bond portfolio in the industry — shed 42.5% since over the same period.
Share value over that time fell $4.45 to $6.03 Friday from $10.48.
Ambac Financial Group Ltd., once the second-largest insurer but more recently a potential case for bankruptcy, fell 64.8% from April 23. That knocked its share price down $1.27 to $0.69 Friday from $1.96. It is 31 cents below the minimum level required to be on the New York Stock Exchange.
Over those same seven weeks, the benchmark S&P 500 fell 10.3%.
Despite the recent performance, Daniel Kim, an analyst at JPMorgan, has a long-term price target for Assured of $40 per share — about 2.7 times its current value — making its current price a bargain.
On May 20, Kim issued a report giving Assured an overweight rating for the next six to 12 months.
Assured also sees its current market value as underpriced.
In late May, it repurchased more than 700,000 shares at $14.74 apiece, completing a two-million share buyback program authorized by its board of directors in November 2007.
Additionally on June 4, Assured submitted 14 filings to the Securities and Exchange Commission indicating that different directors had purchased company stock.
Kim called the actions “notable.”
“That management used up its entire remaining buyback authorization in such a short period makes this a notable event, signaling [management’s] frustration over the recent sell-off,” he said.
“Given the strong capital position that AGO is in currently, we expect further repurchase authorization to be granted by the board in the near future in order to give AGO the ability to take advantage of market opportunities and provide a deterrent to short sellers.”
A Shift in Perception
However, to understand the recent sell-off in insurer stocks, Michael Pietronico, chief executive officer of Miller Tabak Asset Management in New York, said one has to comprehend the broader shift in perception among municipal bond investors resulting from the financial crisis.
Prior to the crisis, nine insurers led by MBIA and Ambac backed more than half of all primary market municipal issuance. Ultimately, most of the monolines collapsed and were downgraded due to their exposure to billions of dollars of toxic assets they insured.
The lone survivor, Assured Guaranty, backed 8.7% of total municipal market issuance last year, and 6.4% of volume to date in 2010, according to Thomson Reuters.
None of the municipal debt backed by Assured, MBIA, or Ambac has so far gone unpaid. But Pietronico said the value of insurance has still been compromised in the eyes of investors.
“It’s not so much about failing to pay on defaulted bonds,” he said. “It’s the fact that their business model did not hold up when it was needed the most. The test of the value of insurance was basically the financial crisis, and from many investors’ point of view, the insurers failed.”
Pietronico added that the re-emergence of the industry seems unlikely because investors are now more concerned with “the underlying credit quality of the bonds, because that will ultimately drive the price of the bonds and performance of the bonds.”
The more recent decline in shareholder value coincides with the latest slew of headlines and stories shining a harsh light on the muni market.
Fortune Magazine, which in February 2008 said it was “a perfect time to be buying municipal bonds,” more recently compared U.S. states to the debt-ridden countries in Europe and in mid-March concluded that “astute investors have already begun selling municipal bonds.”
Warren Buffett, speaking before the Financial Crisis Inquiry Commission earlier this month, suggested that if there is no federal guarantee behind municipal debt, current ratings will one day look “crazy” in retrospect.
“I don’t think Moody’s [Investors Service] or Standard & Poor’s or I can come up with anything terribly insightful about the question of state and municipal finance five or 10 years from now,” he said, “except for the fact there will be a terrible problem and then the question becomes: will the federal government help?”
Such negative commentary seemed to spook stock market investors.
Additional bad news for bond insurers came as a result of what has been good news for many other market participants.
In April, Moody’s and Fitch Ratings each recalibrated their municipal ratings to a global scale, causing thousands of bonds to receive de facto upgrades of one or two notches. Some bonds rallied significantly after the ratings shift.
Justin Hoogendoorn, managing director at BMO Capital Markets, called the recalibration “the largest, by far, ratings revision in 35-40 years of ratings history.”
He said the new scales’ immediate impact was to broaden the market’s buyer base, providing additional liquidity and marketability to bonds, something that bond insurance had historically done.
Among municipal issuers that have traded higher is California. The state’s 10-year tax-exempt debt tightened by 34 basis points over a several week period following the recalibration, dropping to 102 basis points from 136 basis points above triple-A Municipal Market Data levels, Hoogendoorn noted.
Business Model Questioned
Lower borrowing costs, more liquidity, and better marketability are all selling points for what you can achieve using bond insurance. With recalibrations helping on all three fronts, the business model of insuring bonds — which involves “renting” the guarantor’s higher rating — comes into question.
“It’s still a bit early to tell — it’s only been since the end of April,” Nick Krzemienski, vice president at Capital Markets Advisors LLC, who formerly was a managing director at MBIA, said of the recalibrations. “You’re not going to know the macro effect of it, but you’ve got to realize hundreds of credits got bumped up, in many respects into the double-A bucket.”
Moody’s, which has a negative outlook on the bond insurance industry as a whole, has graded 54.7% of new issuance this year double-A or higher.
The double-A category is of crucial importance because Assured Guaranty, which is rated AAA by Standard & Poor’s, has a Aa3 rating from Moody’s. As more credits are rated on par with the insurer, there’s less incentive to pay for credit enhancement.
In 2006, when bond insurers were thriving, the spread between natural triple-A rated general obligation bonds and insured bonds ranged between 11 and 15 basis points, according to MMD, meaning that buying insurance resulted in yields very near the natural triple-A.
Over the last six months, the spread between natural triple-A bond yields and insured yields has been between 57 and 81 basis points.
The wider spread means issuers aren’t saving as much by wrapping their debt with insurance.
“Overall, it’s not making any tangible difference in the borrowing costs, which effectively is keeping [the insurers] locked out of the market,” Pietronico said.
Meanwhile, to increase business volume, one tactic the insurers could adopt would be to diversify further into lower-graded credits where there is a greater need for bond insurance. However, doing so would increase the risk of their portfolios.
As Moody’s wrote in November 2008, “the preservation of a low-risk business profile” is a core objective of the insurers.
The agency also said the high ratings historically given to insurers was based on their portfolios being diversified investment-grade credits with low volatility.
However, in an interview on Friday, Moody’s analysts said insurers don’t necessarily have to go down the credit spectrum in order to increase market share. They agreed that the pool of potential buyers for insurance has diminished compared to before the crisis, but said plenty of smaller, high-grade credits could still benefit from the enhancement.
“There are sectors of the muni market — smaller and higher-risk municipal issuers — that are finding it difficult to raise debt at prices that they like to raise debt, without the wrap,” said Stanislas Rouyer, senior vice president and team leader of Moody’s specialty insurance team.
Moreover, Arlene Isaacs-Lowe, another senior vice president on the Moody’s team, pointed out that even though the savings resulting from wrapping bonds with insurance has gone down, insurance has other lasting value.
“There is value to the product in providing liquidity and due diligence, and loss mitigation efforts, for perhaps some of the smaller credits where it’s tougher for them to come to the market because of their size, albeit they have to have a relatively high rating or credit profile,” she said.
Isaacs-Lowe said negative headlines about the municipal market could be hurting the insurers now, but increased strain could eventually have the effect of validating the need for the product, particularly as insurers work on behalf of investors to make sure they get full and timely payments.
“Once there is some clarity around any differentials between the losses on wrapped transactions and comparable losses on unwrapped transactions,” she said, “there could be an additional story there in regards to greater validation of the loss-mitigation value.”
