The New York State Department of Financial Services has licensed a new bond insurer with the right to wrap bonds in 26 states.
Over the next six to nine months Build America Mutual Assurance Co. plans to be licensed in all the important states it wishes to practice in, according to BAM board chairman Robert Cochran. Ultimately, it plans to be licensed in all 50 states.
BAM is starting an accelerated multi-state licensing process Tuesday, said chief executive officer Seán McCarthy.
Standard & Poor’s has awarded the new company an AA rating with a stable outlook. BAM has had discussions with Moody’s Investors Service and will continue them as it gains an operating history, a BAM source said. Moody’s has not issued a rating of the insurer and does not comment about companies it does not rate, said spokesman Abbas Qasim.
BAM will initially insure AA-minus and A-rated bonds up to $100 million and BBB rated bonds up to $75 million, Cochran said.
The company is to act as the first mutual bond insurer serving the U.S. municipal bond market. As a mutual insurer, the company’s insured issuers will also be its owners.
It will insure only investment-grade revenue and general obligation bonds issued to fund essential government facilities and services.
The company is starting with $500 million in funding plus $100 million pledged in collateral trusts. Its capital will grow as its insured portfolio grows.
Issuers will be charged 1% of par to become a “member” (i.e. owner) of BAM and an additional 10-year upfront risk premium for the company to insure the bond. If bonds extend beyond 10 years, the issuer would make annual installment premiums through maturity.
Along with saving on interest, BAM members will be able to get future dividends and to reuse their member contribution for refundings. When issuers come to BAM with completely new issues they would have to pay an additional new member contribution as well as the risk premium. As the company’s capital grows, BAM expects to increase its limits on the maximum size bond it will insure proportionately, Cochran said.
The company will be based in New York City and initially employ about 40 people. Within two years, employment may grow to about 100, according to the New York Department of Financial Securities.
Build America Mutual “should enable smaller and mid-sized communities to undertake essential capital projects that are good for the economy,” said Department of Financial Services superintendent Benjamin Lawsky. “The department will closely monitor Build America Mutual to safeguard against the problems that the bond insurance market encountered during the height of the economic crisis.”
BAM will start to underwrite (research) possible issuers to wrap Monday, McCarthy said. It should start actually wrapping bonds in September. It expects to insure $10 billion in par value in the next 12 months and $15 billion in the following 12 months, according to McCarthy.
BAM will not insure structured securities, which contributed to financial problems for bond insurers in the past recession. Nor will it insure variable-rate bonds. It will only insure U.S. essential public-purpose municipal issuers of fixed-rate, fully amortizing debt.
White Mountain Insurance Group Ltd. is providing BAM’s initial capital. They were investors in former bond insurer Financial Security Assurance Inc., in which McCarthy and Cochran held leadership roles. White Mountain is also providing capital on BAM’s first loss collateral trust. The trust will cover all losses on bonds up to 15% of par value. In this way BAM’s central capital will only be affected by major defaults.
BAM starts with $600 million in claims-paying resources and no exposure against its capital. As its muni insurance exposure grows, its surplus and claims-paying resources will also grow. BAM has a target operating leverage of 50 to 60:1 over the long term.
BAM’s leadership has extensive experience in bond insurance, a fact that contributed to S&P’s strong rating. Cochran co-founded FSA in 1985. He was chief executive officer from 1990 to 2009. Along with serving as president and chief operating officer of FSA, McCarthy held those positions at bond insurer Assured Guaranty Ltd.
Other professionals joining BAM are: Scott Richbourg, former executive director of the southern group for Morgan Stanley public finance; Elizabeth Keys, who will be the chief financial officer, and who was CFO at Guy Carpenter; Alex Makowski, former managing director of FSA; Suzanne Finnegan, former executive vice president at Wells Fargo Bank NA; Elizabeth Hill, who engaged in surveillance at FSA; Laura Levenstein, former senior managing director at Moody’s; David McIntyre, former global head of development standards and control at BlackRock Inc., and Betsy Castenir, former managing director of corporate communications at FSA.
BAM will only guarantee secondary market insurance when it has guaranteed the primary transaction or when it has a contractual relationship with the primary issuer and can keep getting information about their credit, McCarthy said.
Cochran was asked about how viable it was to launch a bond insurer at this time when credit spreads were tight.
“We’ve studied this very carefully,” Cochran said. Despite the low rates, we feel there will be sufficient savings for issuers to be attracted to us, he said.
The National League of Cities is endorsing the new credit enhancer. “BAM’s model as a mutual is attractive to cities as it allows them to receive additional benefits as the program grows,” said NLC executive director Donald Borut.
In the last few years, only Assured Guaranty Ltd. has been offering new insurance for muni bonds. Assured Guaranty currently has a AA-minus rating from S&P and an Aa3 rating from Moody’s, though it placed Assured on downgrade review.
“The entrance of a new player into the bond insurance business underscores the importance of the product and the expected growth in demand for it, as well as the opportunity that fresh capital sees in participating in this market,” said Assured spokeswoman Ashweeta Durani.
BAM’s entrance into the market is a positive for both issuers and investors, said RBC head of U.S. municipal finance Chris Hamel. The way BAM has set up its operation means it has learned the lessons of the financial crisis, he said.
