Healthy bond insurers are not expected to return to the municipal world for at least two or three years, leaving investors without a safety net for the foreseeable future, analysts at Moody's Investors Service said.
And while there have been signs of new entrants into the bond insurance space — most recently the announcement from Radian Group and the National League of Cities that they will explore the formation of a mutual bond insurance company — new startups aren't likely to have an effect on the market for several more years.
If the bond insurance industry does make a recovery, it appears likely it will be with public finance insurance being kept separate from structured finance insurance. That was the main contributor to the fall of MBIA Inc., Assured Guaranty, Ambac Financial, and Radian, which said its new muni bond insurer would focus solely on public finance and will not guaranty structured finance products.
Similarly, MBIA and Assured are in the process of separating and winding down their structured finance books.
Once triple-A rated insurers, MBIA's muni bond insurer National Public Finance Guaranty is rated Baa1, Assured Guaranty Municipal Corp. is rated Aa3, and Ambac Assurance Corp. had its ratings withdrawn.
Separating muni policies from structured finance policies "are positive developments for the prospect of a revival of healthy bond insurers," wrote Moody's analyst Helen Remeza. But she noted that investors aren't out of the woods yet.
"Given that most bond insurers are now either bankrupt, restructured, unrated, or carry low ratings, it's clear that, relative to the years preceding the financial crisis, there is now a higher risk that investors' insurance claims will not be fully recovered," she added.
For example, bondholders in the Las Vegas Monorail bankruptcy that was insured by Ambac could see a large cut in their investments. Remeza wrote that under the current plan, bondholders will receive $111 million on cash of the $451 million of insured bonds. But on a positive note, all claims have been paid on bonds insured by Assured for Harrisburg, Pa., and MBIA for Vallejo, Calif. "While we do not expect wide-scale municipal defaults, sustained economic weakness and related municipal credit stress will likely increase the volume of defaults over the next two or three years," Remeza wrote.
While analysts noted that defaults are rare and infrequent, the rating agency expects to see an increase in defaults from current levels. Associate analyst Dan Seymour wrote that defaults are expected to affect smaller issuers that don't often come to the public markets.
According to Moody's, municipal downgrades have outpaced upgrades for 10 consecutive quarters, but only two local government issuers have defaulted among the 8,500 counties, cities, and school districts that Moody's rates. Since 1970, 59 municipalities that are rated by Moody's have defaulted, and of those, only seven have been a county, city, or school district, and only three defaults have been on general obligation bonds.
Moody's expects to see a continued low rate of default because muni borrowers don't expose themselves to refinancing risks as much as corporate issuers. Municipal debt is primarily long term, so borrowers don't rely on market access to repay debt through rollovers.
Municipalities have also learned their lesson by watching other municipalities default that borrowers don't gain much by defaulting and have a lot to lose. Seymour wrote that debt service typically represents 5% to 7% of municipal expenditures, and so even cutting debt expenses won't do much to ease the burden of rising expenses compared to revenue.
Defaulting also makes coming back to the public market again extremely expensive. "Losing market access would likely result in being shut out from short-term note and bank-lending markets that can help municipalities bridge cash-flow gap," Seymour wrote. "In almost all cases, it is more cost effective to meet debt service and cut other expenses."
