The municipal debt insurance business is coming back to life, after losses during the financial crisis nearly wiped out the industry by impairing the claims-paying ability of monoline bond guarantors.
A spate of high-profile municipal credit events in recent years, culminating with Detroit's Chapter 9 filing last July plus ongoing concern over Puerto Rico's finances, has stoked investors' awareness of municipal default risk and spurred demand for protection. Despite widely cited financial woes among both municipalities and monolines, guarantees have worked largely as anticipated to protect holders of insured securities issued by Vallejo, Calif.; Jefferson County, Ala.; Harrisburg, Pa.; Stockton, Calif.; San Bernardino, Calif.; Rhode Island EDC (38 Studios); and most recently, Detroit. (The Las Vegas Monorail was a notable exception.) Secondary market transactions - a profitable channel in which monolines sell coverage to investors rather than to municipal borrowers - appear to be growing, although reliable data is scarce.
Prospects for improved bond insurance volume and pricing led Standard & Poor's to upgrade two monolines on March 18. The S&P rating on Assured Guaranty - the only monoline that continued writing new business through the financial crisis - went from AA- to AA. The rating on National Public Finance Guarantee (NPFG) - the dedicated municipal insurance arm of MBIA - was raised from A to AA-.
The upgrade opens the door for NPFG to eventually resume insuring municipal debt for the first time in six years. At present, the only active municipal insurers are Assured Guaranty and Build America Mutual, which was launched in 2013. Assured is writing new business both at the AGMC and through its muni-only subsidiary, MAC. Four other insurers are classed as "inactive" or "runoff" because they no longer provide new guarantees and their existing portfolios have been transferred to other guarantors or segregated accounts.
After the monoline sector sustained crippling losses and rating downgrades due to insuring asset-backed CDOs and other non-municipal securitized instruments, the proportion of new municipal supply that was insured cratered from a peak of 57% of all muni issuance in 2005 to 3.5% by 2012, according to Bond Buyer. Insured penetration inched up to 3.6% in 2013. S&P expects the proportion to climb to 7%-8% by the end of 2014. Municipal debt insurance is concentrated among bonds issued in California, New York, Pennsylvania and Texas.
One way to estimate the value of municipal bond insurance is to analyze how market participants value insured and uninsured bonds of identical issuers and similar structure. The following observations emerged from comparing Interactive Data evaluated price movements since June 2013 for bonds from three well-known troubled issuers.
1. Interactive Data has observed that a monoline guarantee maintains significant value for PREPA and other challenged names, versus uninsured bonds of the same issuer.
2. There are significant trading value differentials amongst insurers, with the biggest factor being whether a company is active or in runoff. Even among runoff insurers, price comparisons among bonds insured by different companies point to differences in relative strength based on the specific insurer.
3. Bonds insured by runoff companies typically trade significantly cheaper the longer the bond's maturity date. The difference likely reflects uncertainty with respect to the sustainability of claims paying ability: even a lower-rated guarantor may have adequate resources to pay claims in the next few years, but may be viewed as less reliable when looking out a decade or longer. For example, after S&P downgraded Tuomey Healthcare System from BB to CCC on Oct. 3, 2013, Interactive Data's evaluated price for a CIFG-insured Tuomey bond due in 2035 (CUSIP 83703EKE) slid from the low-$80 range to under $60 in the ensuing month - a decline of more than 20 points. Meanwhile, the evaluated price for a CIFG-insured Tuomey bond due in 2017 (CUSIP 93703EJZ) dropped just 2 points, from approximately $97 to $95.
A recent settlement of bondholder claims for Detroit unlimited tax general obligation bonds (ULTGOs) turned out favorably for bond insurers. All ULTGOs are insured. While early plans from the City of Detroit emergency manager and bankruptcy court had estimated bondholder recovery at 20% and then 15%, the parties ultimately agreed to pay 74%. As a result, insurers must pay out only 26% to make bondholders whole, rather than being on the hook for as much as 85%. This is especially important for the inactive insurers, whose weaker credit profiles could have been stressed by larger payouts for Detroit ULTGOs.
Pricing, evaluations and reference data are provided in the US through Interactive Data Pricing and Reference Data LLC and internationally through Interactive Data (Europe) Ltd. and Interactive Data (Australia) Pty Ltd.
Jon Barasch is Director, Municipal Evaluations, and Jon Jacobs is Senior Fixed-Income Analyst for Interactive Data.