Now that Assured Guaranty Ltd. has cemented a monopoly in bond insurance, it has done what any other monopolist would do: raised prices.
The Bermuda-based insurer is the only company writing insurance on municipal bonds today.
Bond insurance used to be a crowded field. Seven viable players once fought for customers in this business, and for much of this decade more than half of municipal bonds came to market wrapped in triple-A rated insurance.
The credit crisis torpedoed the balance sheets of most bond insurers, dragging their capital cushion beneath the minimum required by regulators to remain in business.
One by one, Assured's competitors slip into runoff, cut deals with regulators just to stay alive, or regress into oblivion.
Assured, which absorbed former competitor Financial Security Assurance and renamed it Assured Guaranty Municipal, is the lone survivor. The company wrote insurance on $26.5 billion of municipal bonds in the first three quarters, a bit more than 9% of the market.
That is basically all the business anyone is writing.
With Assured's virtual monopoly secured, its pricing power has beefed up accordingly.
Bond insurers charge municipalities an upfront fee to guarantee all interest and principal payments on a bond.
In theory, a municipality would pay a lower interest rate on a bond that it has insured because of the perceived fortification in credit quality.
The price of a bond insurance policy is based on two things: how much a municipality saves by buying the insurance, and how much of those savings the municipality is willing to fork over to the bond insurer.
Assured is benefiting from a jump in both categories, the company said at an investor conference earlier this month.
In 2006, Assured charged $285 million in premiums to insure $44.93 billion in debt, according to a company presentation. That figure implies the company charged 63 cents in premiums for every $100 in face value of the bonds it insured.
Through late September of this year, the company charged $400 million in premiums on $28.82 billion of insured debt, implying a charge of $1.39 per $100 face value.
In other words, premium prices have more than doubled.
Jason Falzon, an Assured vice president of secondary markets, said this is mainly because issuers are saving more by purchasing insurance.
Falzon said when Assured evaluates an application for insurance, the company estimates how the issuer's bonds would price with and without insurance.
That difference is the savings a municipality is paying for when it buys bond insurance. A greater difference, or spread between the uninsured and insured interest rates, implies more value and logically a higher price for the insurance policy.
Fitch Ratings and Moody's Investors Service rate Assured's municipal insurance subsidiary double-A. Standard & Poor's rates it AAA.
According to the Municipal Market Data yield curve, single-A rated 10-year municipal bonds yielded an average of 17 basis points more than double-A munis in 2006.
This year, the average differential is almost a full percentage point. That means a typical single-A rated issuer would save a lot more money today by pasting Assured's double-A rating to a bond than it would have saved in 2006.
That is mainly why premium prices have gone up, according to Falzon. "I would say it really is more a function of credit spreads than anything else," he said.
A second factor is also at play. When competition in the industry was at its fiercest, bond insurers sometimes captured less than half of a municipality's savings through insurance, said Bill Hogan, senior managing director at Assured.
Assured now often captures 55% to 60% of the savings, he said.
"We're trapping more of the spread today," Assured chief executive officer Dominic Frederico said at the investor conference.
Hogan is not afraid of new competition encroaching on this pricing power. The current capture rate is reasonable given the increase in credit spreads, he said.
The industry, Hogan added, could brook a few more competitors and still price premiums efficiently.