Assured Guaranty Ltd., the only bond insurer with high enough ratings to be an active player in the municipal market, said debt guaranteed by below-investment-grade insurers should be sold in public auctions in order to improve the market’s perception about the product’s viability.
Through its two platforms, Assured Guaranty and Assured Guaranty Municipal, Assured has been the only guarantor writing new business since mid-2008 when the industry fell apart after risky assets laid waste to the balance sheets of other insurers.
“It’s really a decision that sits in the hands of the Wisconsin regulator, in the case of Ambac [Assurance Corp], and the New York regulators, in the case of everybody else,” Sean McCarthy, president and chief operating officer at Assured, said in an interview. “We think that the most important thing they could do is to put those portfolios in the hands of somebody that’s higher rated to help validate the product and resuscitate the market. Our view is that there’s been more havoc wreaked on the market by the regulators not taking speedy action on behalf of municipal bond investors.”
The idea doesn’t appear to have much traction with regulators, or with the insurers owning the portfolios in question.
The New York Insurance Department, the regulator of Assured as well as MBIA Inc., which holds the largest public finance portfolio, declined to comment. But Sean Dilweg, the Wisconsin insurance commissioner, whose office regulates Ambac, said that a public auction of the portfolio has not been in the cards.
“We have considered every proposal that makes sense, and will continue to do so. An auction of public finance portfolios is not currently on our list,” he said. “It may be best for Assured Guarantee, but may not be in the best interests of Ambac policyholders. My mandate as a regulator is to protect the interests of Ambac policyholders.”
Nor was the suggestion welcome to MBIA, which has been struggling to launch a muni-only insurer, National Public Finance Guarantee Corp., since February 2009. The new insurer is officially open for business but remains inactive because of ongoing litigation.
“We believe that investors are most interested in obtaining coverage from stable, very well-capitalized guarantors whose insured portfolios do not contain potentially volatile structured finance exposures,” Tom McLoughlin, National’s chief executive office, said in an e-mailed statement.
His comment refers to the fact that Assured Guaranty and Assured Guaranty Municipal each contain structured finance products in addition to municipal bonds.
AGM only writes policies for public finance, but 19% of its portfolio is legacy structured finance assets, according to Assured’s online fact sheet. About 85% of the assets are expected to be run off by 2015.
“National stands alone in the industry as the only insurer whose portfolio consists exclusively of U.S. public finance credits and whose cut-through reinsurance contracts directly benefit policyholders,” McLoughlin said.
The public finance portfolios of National, Ambac, and Syncora Guarantee Inc. total more than $750 billion.
For McCarthy, a public auction of those portfolios would help bondholders because if the purchaser was an investment-grade entity, the value of the bonds would rise.
“We think there’s a fair amount of interest for people to put the capital up to either buy those portfolios and manage them in run-off, or buy them and start a new company,” he said. “Or, in the case of us, buy them and manage them.”
He added: “In any of those scenarios, those portfolios would become double-A, which would help the market and reinvigorate the product. In large part, the market is damaged by the fact that 60% of the bonds that are held by individuals have a wrap on them that’s not investment grade. Fixing that would be critical.”
However, recent history suggests that swapping insurers might not run so smoothly.
In October 2008, Assured agreed to reinsure $13 billion of CIFG Assurance NA’s public finance portfolio. The two parties “finalized” the deal in January 2009, but the process of transitioning from one insurer to the other is not yet completed.
Most recently, Assured last week notified CIFG that one issue in the transaction has been rejected from the reinsurance agreement for not meeting the requisite criteria.
The assets in question are 2006 revenue bonds issued by the Xenia Rural Water District in Iowa, which mature in 2031.
At the time of the agreement, the bonds were rated BBB by Standard & Poor’s, but in August 2009, the bonds were downgraded to BB, or below investment grade.
Assured notified CIFG that only investment-grade credits were part of the transaction, prompting CIFG to point out that downgrades occurring after October 2008, when the deal was agreed upon, should not affect the reinsurance agreement.
But McCarthy said the issue is that Xenia dipped into its reserve fund to make debt payments prior to when the agreement was finalized in January 2009.
According to the Xenia bond’s description, the district dipped into its reserve fund in December 2008, and again in June 2009 and December 2009.
“The fact of the matter is that prior to us acquiring that portfolio, Xenia drew on its debt-service reserve fund a couple of times and was in default,” McCarthy said. “How can a municipality that defaults still be investment grade?”
Corey Friedman, Standard & Poor’s primary credit analyst for Xenia, said dipping into the reserve fund points to fiscal distress, but it may not necessarily constitute a technical default or strip the credit of its investment grade.
“You could have an instance where it would potentially keep the investment grade,” he said. “There isn’t an automatic mechanism saying, 'You are in technical default as per your rate covenant, therefore you are not investment grade.’ There’s not any direct correlation to that.”
But McCarthy said the issue isn’t what Standard & Poor’s rated the bonds, but what CIFG’s internal ratings were. He added that CIFG failed to notify Assured that the district had dipped into its reserve fund before the agreement was finalized.
“This is not a case of a transaction becoming non-investment grade after the contract was signed and then our disputing it,” McCarthy said. “We’re not trying to skirt our responsibilities whatsoever. In this particular case, it’s patently clear to us that there was a default prior to our agreeing to acquire the portfolio. Based on the terms of the reinsurance agreement, there is no way they should have included this transaction in the portfolio.”
CIFG declined to offer any additional comment.
To date this year, less than 7% of new issuance has been guaranteed, as the market has turned away from credit enhancements after multiple insurer downgrades in 2008 hurt bond prices.
Prior to the financial crisis, nine insurers led by MBIA and Ambac Assurance routinely backed more than 50% of new issuance.
Among the competitors, Assured was one of the smaller players. In the third quarter of 2007, for instance, it backed 1.1% of new issuance, while Ambac guaranteed 26.5% and MBIA insured 21.3%.
Since the credit crisis, the industry has been in shambles, and Assured has done virtually all of the business.
The company’s dominance has allowed it to pull off record profits in the past two years, enabling it to acquire former competitor Financial Security Assurance in mid-2009. However, a lack of competition has hurt the viability of the product.
In affirming the company’s AAA ratings earlier this week, Standard & Poor’s said Assured’s two platforms “benefit from a lack of significant competition in the bond insurance market in the near term.”
However, the agency maintained its negative outlook, noting that the longer-term outlook for the insurance sector is unclear.
“The negative outlook also reflects our view that changes in the industry’s competitive dynamics could hurt the companies’ business prospects,” it said. “The current market has only one active insurer, indicating that investors and issuers are learning to live without insurance. The longer this is true, the more limited the potential for reemergence of a strong and vital bond insurance sector, in our view.”
