The looming expiration of the Build America Bonds program is anticipated to be a net negative for the municipal market, but at least one sector is looking towards Dec. 31 with glee: bond insurance.
“We don’t have a lot of success in the taxable market — they are not true insurance buyers,” Dominic Frederico, chief executive of Assured Guaranty Ltd., told investors earlier this month. “A non-extension, we think, would be beneficial.”
The problem Assured has with BABs is twofold: one, it has difficulty wrapping them; and two, BABs restrict the supply of tax-exempt bonds.
The $156 billion of taxable BABs issued over the last 19 months has been a major boon to the municipal market. Allowing issuers to tap into broader capital markets caused tax-exempt supply in 2010 to shrink to the lowest volume in the past decade, which has contributed to tighter credit spreads and some of the lowest municipal bond yields, ever.
For Assured, which runs the only two bond insurers operating in the market, this hasn’t been a welcome development. Making it easier for state and local governments to borrow on the cheap has been the bread-and-butter for bond insurers over the last four decades. With fewer tax-exempts in the market, coupled with rating agency recalibrations earlier this year, there is reduced incentive to pay for insurance.
Plus, when Assured’s competitors suffered a series of downgrades in 2008, it caused thousands of insured credits to lose their triple-A ratings and liquidity, damaging the market’s perception of the value of insurance.
Assured’s two platforms — Assured Guaranty and Assured Guaranty Municipal — are rated Aa3 by Moody’s Investors Service and AA-plus by Standard & Poor’s. They have struggled to keep demand alive as the lone insurer in the market. They have wrapped about $24 billion of munis so far this year, or about 7% of total market volume.
Private insurers have backed 164 BABs totaling $3.5 billion, or 2.26% of volume since inception, according to Thomson Reuters.
Frederico said Assured’s penetration is so minimal because BABs tend to be issued by highly rated borrowers.
According to Thomson Reuters, nearly two-thirds of uninsured BABs rated by Moody’s since inception were Aa3 or higher, and more than 70% of uninsured BABs were rated AA-minus or higher by Standard & Poor’s.
“Obviously, that’s not a market, based on our current ratings, that we have real impact on,” Frederico said.
Borrowers with double-A or higher ratings typically come to market at a lower yield than insured credits, according to Municipal Market Data. Even A-rated issuers, Assured’s core market, only save an average of 10 basis points on 10-year bonds by using insurance.
In addition, BABs are predominantly bought by institutional investors, whereas insurance has become a niche product appealing to a base of retail investors.
Assured had made attempts to expand its footprint in the retail area, with advertisements directed at retail buyers and a proposed partnership to sell insurance in the secondary market via TheMuniCenter, an online trading platform.
If BABs expire on Dec. 31, as scheduled, those efforts could pay off in 2011.
A halt to BAB issuance could lead to the sale of more bonds ripe for being insured, Frederico said. An increase in tax-exempt supply would drive borrowing costs higher and probably kick spreads out.
In the nearer term, however, Assured’s market penetration could shrink as BAB issuance in the final weeks of 2010 could dominate the market, he added. Indeed, $11.2 billion of BABs were issued in October, helping taxable issuance account for 38% of new volume.
But the assumption that tax-exempt issuance will increase next year if BABs expire does not mean 2011 will be a game-changing year for the insurer, said Daniel Berger, strategist at Thomson Reuters.
Prior to the credit crisis, insurers routinely enhanced about half of all new issuance in the market. Now, that share is consistently less than 10%. Berger sees no reason for that penetration to increase.
“We don’t see this as a rebirth for bond insurance,” he said “It could be material for them and there will be some increased usage, but we don’t think it’s going to be as widespread as they may think.”