Sell Side

Downgraded Assured Guaranty to Launch New Muni Bond Insurer

After a two-notch Moody’s Investors Service downgrade, Assured Guaranty announced Friday that it intends to launch a new municipal-only financial guaranty insurer this year that will not carry a Moody’s rating.

Moody’s downgraded the insurance financial strength rating of Assured Guaranty Municipal Corp. to A2 from Aa3 on Thursday night. Moody’s also downgraded the ratings on Assured Guaranty Corp. to A3 from Aa3 and Assured Guaranty Re Ltd. to Baa1 from A1.

Assured, which insures municipal bonds and international infrastructure financing only, is responsible for wrapping almost all of the municipal bonds in recent years, with a 99.7% market share in 2012, according to Thomson Reuters data.

Assured Guaranty Corp. insures both public finance and structured finance obligations and wrapped only two new issues last year.

Dominic Frederico, president and chief executive officer of Assured Guaranty, said the Moody’s rating process is seriously flawed. The report on the multi-notch downgrades “reveals contradictions and inconsistencies that seriously discredit it,” he said.

“Moody‘s ratings now appear to be determined by unsupported qualitative factors and assumptions about future product demand, future profitability and future stock price that have little or no relevance to the company‘s actual ability to meet all of its financial obligations with the highest certainty,” Frederico said in the statement, which outlines the company’s specific responses to the Moody’s report. “When a company‘s financial strength and the quality of its insured portfolio are no longer the dominant factors in its ‘financial strength rating,’ there is a serious flaw in the rating process.”

Frederico pointed out that the ratings report stated that Assured Guaranty Municipal has capital adequacy that corresponds to a Double-A range, and insured portfolio characteristics that are high investment grade.

Matt Fabian, a managing director at Municipal Market Advisors, also noted the bond insurer’s current credit quality, saying the downgrade came as a surprise.

“Moody’s took a forward-looking stance, as opposed to looking at their current capital adequacy,” he said. He added that the action will not likely have much impact on the market.

Frederico said that in the three years since its last review from Moody’s, when AGM and AGC were assigned Aa3 ratings, Assured has materially increased its financial strength while significantly decreasing its insured exposures.

“We are confident about our ability to serve our markets and build our business based on our proven value proposition and our track record of solid performance,” Frederico said. “We also have confidence that, irrespective of Moody‘s action, informed issuers and investors understand our true strength and the value our guaranty provides.”

Most traders said immediate reaction was muted on Friday and analysts said they don’t expect the downgrade to have any major impacts.

“I don’t think munis are going to sell off or that this will create any kind of broad market concerns,” said Alan Schankel, managing director at Janney Capital Markets. “But I do think that it will make it more difficult for Assured Guaranty to write new business.”

New business has already been declining with total consolidated new business production for nine months ending Sept. 30 at $112 million, down from $128 million the year before, according to the company’s financial documents.

In its report Moody’s noted AGM’s low levels of new business production, affected by the dramatic decline in its industry. Analysts believe its profitability will remain under pressure.

“While AGM benefits from its position as the most active player in a smaller industry, its overall business activity, as measured by the present value of gross premiums written, remains well below pre-crisis levels,” Moody’s analysts said.

BTIG analyst Mark Palmer said the downgrade would likely result in an initial kneejerk reaction among Assured Guaranty’s shareholders, but doubts that any downdraft will persist.

“Even though new business represents just another incremental source of value to AGO at this point – low interest rates have rendered bond insurance less attractive to issuers such that the amount of new business written is already low by historical standards – those who have followed the company during the last 10 months know that the company has developed detailed contingency plans for responding to a downgrade,” he wrote in a research note.

New business and expected future profitability was just one of the five factors that Moody’s focused on in its rating analysis. The other factors were franchise value and strategy, insurance portfolio characteristics, capital adequacy, and financial flexibility.

Moody’s said the rating could be lowered if “the quality of its insured portfolio meaningfully decreased or capital was withdrawn without an associated reduction of risk, or if profitability reduced materially.”

The rating could be upgraded if a significant rebound in business origination at attractive pricing levels and financial flexibility improves.

“However, fundamental challenges inherent in the business model make a return to the Aa rating level unlikely,” the report said.

Schankel said that in the future, when interest rates start to rise, dynamics for the bond insurance industry will start to change.

“A lot of their problems have been cyclical as a result of the spread compression and low interest rates,” he said. “It’s just a very difficult place for an insurance company to operate.”

Sean McCarthy, chief executive officer of the only other active bond insurer, Build America Mutual, said there continues to be a significant role for bond insurance in the municipal market.

“Importantly, our mutual structure allows us to operate our business in a manner that builds capital transaction by transaction and eliminates the potential conflicts between policyholder and shareholder interests,” he said.

BAM is rated AA with a stable outlook from Standard & Poor’s, and no Moody’s rating. S&P assigns Assured Guaranty Municipal its AA-minus insurer financial strength rating, with a stable outlook.

Assured Guaranty Ltd. shares rose 2.6% Friday on the NYSE to close at $14.98.


(4) Comments


Comments (4)
The prudent move by AGC would be to raise additional capital to offset the poor industry fundamentals. When the fundamentals improve, return capital to shareholders. AGC's attempt to tell Moody's what is analytically relevant for the rating is self-serving. Federico's actions and refusal to have Moody's rate the new insurer is just another reminder of why we need mandatory independent ratings. Now, I trust AGC less.
Posted by stalker | Friday, January 25 2013 at 4:10PM ET
Moody's has to be given credit here for taking a forward thinking approach after being criticized for not having done so during the financial crisis. AGC on the other hand wants ratings solely based on claims-paying ability, and wants to disregard the rating agencies concern over long-term viability. Insured penetration is at a paltry 3% versus the pre-crisis levels of 55%. I think it is fair to say that ongoing viability is a concern.

I must say the launch of a new insurer, sans a Moody's rating, is interesting. However, AGC will have to reinvent themselves if they are going to survive.
Posted by jcampagna | Tuesday, January 22 2013 at 11:56AM ET
AGC appears to be the victim of the rivalry between Moody's and S&P and to keep themselves relevant. The fact is that actual losses in the bond insurance business have been miniscule (from municipal bond insuring activity). Bond insurance serves a trul worthwhile purpose, especially in times such as these. Driving them out of business through questionable rating calls only reinforces the call by government to reduce the rating agencies role in influencing credit decisions.
Posted by rlehmann | Monday, January 21 2013 at 10:13AM ET
Truly a tough call by Moody's! Should they weigh the weak industry fundamentals or rely, as they did previously, on model driven metrics that speak exclusively to current claim paying strength? We have a live contest between these two approaches given S&P's traditional model driven rating. This may be one of the few instances where a model centric methodology that imbeds every exposure may be better, especially if the macro environment of super tight spreads changes in the next few years.
Posted by mdwjr | Friday, January 18 2013 at 5:05PM ET
Add Your Comments:
Not Registered?
You must be registered to post a comment. Click here to register.
Already registered? Log in here
Please note you must now log in with your email address and password.

Upcoming Events

Already a subscriber? Log in here
Please note you must now log in with your email address and password.