The credit rating agencies and regulators are to blame for the lack of competition in the bond insurance market — both have created an environment that makes it difficult for new capital to find its way into the business, an industry executive said Friday.
"It's hard to imagine that there would be capital providers that would come in under a scenario where there are no controls," said Dominic Frederico, president and chief executive officer of insurance holding company Assured Guaranty Ltd.. "There are no checks and balances, there are no clear regulations so that you would know the rules by which you'd have to play by."
Assured operates the only two bond insurers still writing insurance policies in public finance. Frederico was venting his frustration to investors in a third-quarter earnings conference call.
On Oct. 25, both of Assured's bond insurer platforms, Assured Guaranty Municipal Corp. and Assured Guaranty Corp., were downgraded to AA-plus by Standard & Poor's. The decision was widely unexpected given that both insurer's triple-A ratings were affirmed on June 24.
Frederico called the decision "another unwarranted downgrade." Moody's Investors Service and Fitch Ratings took away AGC's triple-A status in November 2008 and May 2009, respectively.
The unpredictable decisions from rating agencies, coupled with state regulators allowing below-investment grade bond insurers to maintain their portfolios, has created an environment unsuitable to prospective participants and investors, Frederico said.
"The downgrade, we believe, represents changes in S&P's AAA criteria and market outlook rather than any material change in our credit profile or capital position," Frederico said.
He pointed out that since the financial turmoil began three years ago, shareholder's equity has more than doubled to $4.2 billion at Sept. 30, 2010 from $1.6 billion in the third quarter of 2007.
Late Thursday, Assured reported operating income of $222.8 million in the July to September quarter. That marked a 382% increase from the same period a year ago and allowed the company to boast a record quarter for the second consecutive period.
The rating downgrade leaves the public finance market without a triple-A rated bond insurer for the first time since MBIA Inc. hit the scene in May 1974. All of the other triple-A-rated bond insurers were swept lower in the financial crisis after they got stuck holding risky mortgage-related debt they insured.
Frederico said Assured's portfolio of mortgage-related and structured-finance products could only perform as poorly as Standard & Poor's rating methodology assumes it might if there were a nationwide depression involving 1,600 bank failures and a 25% unemployment rate.
"This is truly an unimaginable scenario and one can hardly conceive what would be left of the U.S. economy or our financial system under such conditions," he said.
Frederico said Assured has been able to continue insuring bonds in recent weeks, which "reflects the market's confidence in the strength and stability of our guarantee."
Standard & Poor's full analysis is not available to the public, but in its Oct. 25 report the agency said the downgrade was made in part because of a lack of competition within the insurance sector, which it called "symptomatic of investors' and issuers' diminished demand for bond insurance."
Assured's impressive third quarter results are unlikely to have impacted that assessment. Operating earnings mostly went up as a result of tax benefits, reduced losses on credit derivatives, and a large base of unearned premiums from an acquisition last year. New business production in public finance was $84.5 million, a decline of 45% from the $154.9 million it recorded a year earlier.
In the first 10 months of the year, Assured wrapped about $23 billion of municipal debt, about 29% less than the same period a year ago, Thomson Reuters said.
But Frederico disputed the widespread notion that demand for bond insurance is declining. Instead, he said the decrease in insurance was a result of fewer target-market products available. Indeed, tax-exempt borrowing in the first ten months of the year was $225.2 billion — less than any year in the past decade, according to Thomson Reuters.
"In the quarter, we insured 24% of all A-rated issues, which is an outstanding result," Frederico said. "People, including the rating agencies, talk about the low penetration rates but results like [that] tell a different story."
Higher ratings for thousands of issuers, as a result of upgrades or recalibrations earlier this year, similarly cut into Assured's key market.
"In the pre-crisis time of 2006, only 6.2% of municipal issuers were rated AA-plus or AAA from S&P," Frederico said. "In 2010, that number jumps up to 32.2% of all the issuers."
The same figures from Moody's grew from 8.3% in 2006 to 33.2% in 2010.
"Clearly, the removal of 25% of the insurable market will cause overall market penetration rates to decline," Frederico said. "But it is not reflective of the decrease in real demand for the product."
