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Return of Triple-A Insurers Unlikely

AUG 10, 2011 7:35pm ET
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The municipal bond insurance world will not be directly affected by the U.S. Treasury downgrade, according to municipal analysts. However, the likelihood of the bond insurers regaining their AAA status when the U.S. does not hold that title anymore is very slim.

Standard & Poor’s downgraded the short- and long-term U.S. debt rating to AA-plus, and subsequently assigned negative outlooks to AA-plus municipal bond insurer Assured Guaranty Corp. and Assured Guaranty Municipal Corp. because of their exposure to Treasuries.

“Insurers that were rated AA-plus were assigned negative outlooks, which is consistent with the rating of the U.S.,” said Rodney Clark, managing director at Standard & Poor’s. “That is a direct reflection of our criteria. And our criteria for rating insurers above the sovereign is quite clear. Only in exceptional cases would we rate an insurance company above the sovereign.”

Clark added the insurers that were given negative outlooks, including Assured Guaranty, conduct a majority of the business in the United States and “had direct investment exposure ranging from the low end of 60% of capital invested in U.S. Treasuries and agency debt to up to 205% at highest. So direct exposure is significant.”

And while the downgrade of the United States to a AA-plus is a small increment in credit deterioration, Standard & Poor’s said: “We still believe the carry-on effects to insurers as major investors within their whole market is significant.”

And as a result of Assured’s negative outlook, the debt it guarantees has been placed on negative outlook as well. “Insured debt is rated based on the higher of the rating of the bond insurer or the underlying rating of the insured security and as a result of those actions, most of those issues guaranteed by those two bond insurance groups have been placed on negative outlook,” the rating agency said.

However, most analysts say the impact will be minimal. “One rating service decline of one notch is not going to show much effect,” said Randall Smolik, senior market analyst at Thomson Reuters.

“Anybody who takes a broad range of risk is not likely to be severely affected by the downgrade,” said Chris Mier, managing director at Loop Capital Markets. “The [Federal Reserve] no longer has the capability to provide finance support, and we already knew that. The downgrade doesn’t acknowledge any weakness that we didn’t already know about. In a sense, it’s cosmetic, and I think the environment for someone like Assured is improving because this event hasn’t introduced any new credit risk. Spreads are already wide and appetite for insurance will increase as a result of this.”

And investors who are bullish on the insurance industry maintain the monolines will not be affected. “The downgrade will have no significant impact on the monolines because going from a AAA to a AA-plus does not have significant capital charges,” said Manal Mehta, co-founder of hedge fund Branch Hill Capital. “The market reaction to Standard & Poor’s downgrade has completely reversed any credibility they had. They downgrade the U.S. debt and the 10-year yield falls to almost 2%, so credit quality has a reverse reaction.”

One positive reaction from the U.S. debt downgrade is that it may give Assured Guaranty more opportunities to grab municipal issuers now that more credits are put on review for a downgrade, Mehta added.

Mehta’s fund owns shares of both MBIA and Assured Guaranty.

Tom Kozlik, municipal credit analyst at Janney Capital Markets, said the effect will be minimal. “From the municipal market perspective, municipal insurance is still considered by some investors when buying bonds.”

The negative outlook of Assured “is something people want to know about, but I don’t think it’s mind changing in any sense of the imagination,” he said.

Kozlik added that actions taken by the rating agencies related to the U.S. sovereign rating and their fallout effects have caused many market observers “to really — with a capital 'R’ — question some of the underlying assumptions used by the rating agencies.”

Not surprisingly, holding companies MBIA Inc. and Assured Guaranty Ltd. minimized the effects of the downgrade on the monolines.

MBIA chief financial officer Chuck Chaplin said in a conference call Wednesday that “the metrics that are required to obtain high ratings from Standard & Poor’s are extremely in flux right now with respect to the monoline industry … and the metrics that are used to assess the credit quality of the United States are also greatly in flux. So it’s a little hard to say that one would have an impact on the other.”

Dominic Frederico, president and chief executive of Assured Guaranty Ltd., said the downgrade would have a minimal effect. “We believe the impact of the downgrade of the U.S. government to Assured’s insured portfolios should not be material, as related downgrades should be limited to higher rated states or municipalities, and therefore, the related increase in capital charges should be small.”

“Going from triple-A to double-A or even double-A to single-A-plus is not significant,” Frederico said. “It’s only if you fall out of investment grade that you really see significant changes in capital requirements.”

Frederico said it could also be an opportunity for new business. “From a new business perspective, while we are not trying to make a prediction, if credit spreads widen on municipalities, increasing their cost of funding, this could create additional opportunities for Assured insuring new issues,” he said.

Assured Guaranty Ltd. reported second-quarter operating income of $136.3 million late Monday, bringing the six-month total for 2011 to $385.2 million, a 35.3% increase over the same period in 2010. Not a bad start, considering 2010 turned out to be a record year for company earnings.

MBIA Inc. posted adjusted pre-tax income of $161 million in the quarter, compared up $48 million in the second quarter of 2010. The gain resulted from the usual hodgepodge of volatile derivatives, insurance losses and changes in currency exchange rates.

Frederico called his company’s earnings “strong” and Brown called his earnings “very positive.”

Still, shares in the two companies fell with the rest of the equity market on Wednesday. Assured finished 5.53% lower at $9.93 — its lowest closing price since April 2009 — while MBIA finished 3.12% lower at $6.53, just up from Monday but near its lowest since July 2010.

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