Bond insurance is growing as coronavirus leads investors to seek protection

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One of the pandemic’s many knock-on effects in the bond markets is a shift in investor desire for insured debt, according to Kroll Bond Rating Agency and the agencies themselves.

Kroll recently published a report detailing the bond insurance industry in the COVID-19 environment noting an uptick in insured municipal paper.

“Bond insurance penetration spiked sharply higher to nearly 7% in the first half of 2020, a level not seen since the global financial crisis,” wrote Jack Morrison, associate director, Peter Giacone, managing director, Paul Kwiatkoski, managing director and Karen Daly, senior managing director.

The authors noted the amount of insured munis remains well below historical highs of over 50% back before the Great Recession and a return to that level is unrealistic, but there is still a growing trend of insurance in this market.

Assured Guaranty and Build America Mutual have wrapped a total of $13.65 billion in the first half of 2020, an uptick from the $9.76 billion of deals done in the first six months of 2019.

Use of municipal bond insurance swelled to $14.08 billion from $9.76 billion, a 44.2% increase year-over-year as COVID-19 has created credit concerns, thus leading to more insurance use.

Kroll noted that while putting capital to work to replace the run-off of legacy exposure is a long-term positive for the financial guaranty industry, adherence to strict underwriting standards will remain critical to avoid erosion of the overall conservative risk profile of the remaining active players.

“The percentage of new-issuance insured municipal bonds has hovered in the mid-single digits since 2010, even as annual issuance levels have varied,” they wrote. “Current levels have increased to nearly two-times post-financial crisis lows. Notably, insured penetration for 1H 2020 was 6.9% compared with 5.6% for the same period in 2019 and if the 1H level persists for the remainder of the year, it would be the highest level since 2009.”

“Bond insurance is certainly on investors' minds. The coronavirus has caused so much chaos and lost revenues for issuers so wrapped paper is more meaningful now than before March when the sell-off really went down," a New York strategist said. "I’d say the industry itself is really contemplating what will happen in the next few years with issuer credit so having one of the agencies as a backstop will give investors more confidence in the bonds they are buying.”

The insurers verified the increased interest.

“We are seeing significant increases in new business volume for Assured Guaranty in both primary and secondary public finance markets and increased municipal bond insurance penetration for the Company since the start of the COVID-19 pandemic,” said Dominic Frederico, president and CEO of Assured. “We will continue to work with issuers, municipalities and our investors on meeting their financing and investing needs through our insurance guarantee and strong capital adequacy.”

Dominic Frederico, president and CEO of Assured Guaranty.

Grant Dewey, head of municipal capital markets for BAM said there a “clear increase” in investor interest in insured bonds as the scope of the COVID pandemic became clear.

”That initially drove strong secondary market activity in March and April, then kept insured penetration at relatively high levels as the market stabilized and primary activity picked up,” Dewey said. “We saw particularly strong activity on high-grade credits with underlying ratings in the double-A category, reflecting the importance of the improved liquidity and credit protection that bond insurance offers, and which was recognized in the Kroll report.”

Grant Dewey, head of municipal capital markets for Build America Mutual.

Use of municipal bond insurance swelled to $14.08 billion from $9.76 billion, a 44.2% increase year-over-year as COVID-19 has created credit concerns, thus leading to more insurance use.

"With credit spreads so tight and rates so low, intuitively it makes sense to lock in insurance for a modest premium, with possible credit headwinds ahead," said one New York trader. "People don’t want to pay a lot for insurance, as incremental yield is so sought after, but that said — some of these credits — for 10 basis points why wouldn’t you?"

The trader added that as/if the credit story worsens—insurance will play a bigger part.

"You should see the disparity between the two widen from a liquidity standpoint, but not so sure you are seeing it yet due to the yield compression."

Kroll noted the wider credit spreads, in combination with weakened credit fundamentals in the medium- to near-term, may yield increased opportunities for using bond insurance.

“While KBRA’s Financial Guaranty Global Rating Methodology focuses on claims-paying resources and does not explicitly factor in new business origination or market share, all things being equal, an increased demand for insurance would be a positive credit factor for the industry,” the report said.

“The current environment may present financial guarantors an opportunity to grow their insured portfolios to replace legacy exposure run-off. While this would potentially bolster balance sheets and support future earnings potential, such a development would need to be balanced by adherence to conservative underwriting standards. We believe the pandemic should remain largely a liquidity event for the bond insurers, with the exception of Puerto Rico.”

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Bond insurance Kroll Bond Rating Agency COVID-19 Coronavirus Build America Mutual
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