Sell Side

Volatile Summer Gives Boost to Bond Insurers

Insured municipal bonds are outperforming general obligation debt as investors place more value on guarantees amid falling bond prices and default concerns sparked by Detroit’s bankruptcy.

The yield on uninsured 30-year AAA-rated debt is climbing closer to that on similar insured credit, narrowing the gap between the two to the smallest since April 2011, Bloomberg data show. Yields on the AAA debt jumped 128 basis points from May, while they climbed just 56 basis points on insured debt. A less extreme version of the trend can be seen in Thomson Reuters data, where yields on 10-year A-rated GOs have climbed faster since January than on corresponding insured scales.

Detroit’s bankruptcy filing in July sparked notions of municipal tumult in a market already reeling from a June selloff that was the biggest in more than 20 years, said Dorian Jamison, municipal analyst at Wells Fargo Advisors. Eroding confidence in general obligations may encourage investors to look to insured debt, he said.

“Given the volatility that we’ve seen this summer, I would definitely say it lent to the argument that there is still value to bond insurance,” Jamison said. “The Detroit bankruptcy put in some market participants’ minds the question of the strength of the general obligation pledge.”

Timely principal and interest payments by insurers such as Ambac Financial Group and Assured Guaranty on distressed debt in cities like Detroit, and Stockton, California may change investors’ minds regarding the value of insured bonds, Jamison said.

Bond insurers are on the worst start to a year since the financial crisis bludgeoned the industry and sent some of the biggest financial guarantors into bankruptcy. Insured bonds made up just $5.63 billion of the $175.5 billion in new bond issues, or 3.2%, in the first half of this year. The business, which seemed to be on its way out after several years of declining market penetration, will get a shot of life thanks to bankruptcies this summer, said Richard Larkin, director of credit at HJ Sims.

“Detroit has given a new lease on life to bond insurance,” Larkin said in an interview. “Bad news about municipal credit is the best advertising for a bond insurance company. Fear of investors increases demand for the comfort of insurance.”

Pressure on municipal credit and uncertainty posed by legal questions raised in the Detroit bankruptcy case are bringing attention back to the role of financial guarantors, Kevin Brown, managing director of corporate communications at MBIA, said in an email.

“We believe investors are seeing greater value in the protection provided by insured bonds,” Brown said.

Wells Fargo’s research department favors bond insurance policies issued by Assured and Berkshire Hathaway Assurance Corp., Jamison said in an Aug. 14 report. MBIA’s string of legal settlements has bolstered confidence that the firm will reenter the market, while Build America Mutual’s AA rating affirmation last week by Standard & Poor’s will help the new insurer as it builds its reputation, Jamison said.

Lower-rated bonds have underperformed during the selloff in June and 12 straight weeks of outflows from municipal bond mutual funds, highlighting the benefit of insurance to mid-tier rated debt, said Mikhail Foux, a municipal strategist at Citigroup Global Markets.

“Monolines have cleaned up their act,” Foux said. “Their business model is clear and, to a certain degree, they’re back. They’re much more careful who they do business with.”




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