Bond insurance has seen an uptick in usage over the past year and a half, partly fueled by COVID-19 credit concerns and the growth of taxable bonds that have taken a larger share of total municipal volume and opened up the investor base internationally.
A total of $14.8 billion of par has been wrapped by bond insurance through May of this year, compared to $9.76 billion through the end of May 2020.
The par amount insured in 2020 totaled $34.45 billion, the highest since 2009 when there was $35.40 billion at the tail end of the Great Recession. Insurance hit its peak in 2005 when $232.98 billion was insured, the highest year dating back to 1986. In 2007, the total insured fell to $201.02 billion and in 2008 plummeted to $72.18 billion.
Insurance has been gaining, but it is not likely to reach the levels pre-crisis when more than 50% of the market was wrapped. The COVID-19 pandemic created a lot of uncertainty and credit concerns for issuers and investors alike, and a larger taxable portion of the market has contributed to insurers' growth as well.
"COVID helped spur usage — as states and local governments were expected to have a hard time balancing their budgets," said Howard Cure, director of municipal bond research for Evercore Wealth Management.
While some of the uncertainty has lifted with federal aid and the increase in vaccination rates clearing the way for reopenings across the country, certain sectors are still struggling. These include airports, transportation-related credits, as well as issuers whose tax bases are tied to tourism, such as hotel taxes, restaurants and entertainment venues that have been hit hard by the pandemic.
"Deals with bond insurance have become more popular, as it covers credit concerns and provides liquidity," Cure said.
"The big question remains, will investors stay with insurance because it provides extra protection and are they concerned about credit issues once additional federal aid is no longer available?"
Taxable municipal bond issuance has also increased the past few years and with that comes a broader investor base with international investors taking a stronger interest in munis without the institutional knowledge of issuer credit profiles.
Taxables totaled $146.46 billion in 2020, the highest level in a decade when there was $151.88 in 2010, during the Build America Bond era. If BABs are eliminated from the taxable total and market share in 2009 and 2010, the 2020 figures are the highest on record.
In 2020, there was a total of $34.17 billion of insured municipal issuance, of which $10.01 billion was taxable, this excludes $747.7 million of corporate CUSIP taxable insured par. For the first five months of 2021, $4.40 billion of taxable bonds were insured.
Build America Mutual has seen significant increases in utilization on taxable new issues over the past couple of years, according to the mutual U.S.-only bond insurer. "The trend accelerated after the initial spread of COVID-19 last spring, and has been sustained since then," BAM officials said.
BAM's taxable insured par amount totaled $1.8 billion through May, 31, 2021, making up 28% of its total insured par. That is up from $914 million through May 2020, and 19% of BAM's insured par amount was the taxable variety through May 31, 2020. These figures do not include secondary market insurance.
For the first five months of 2021, Assured Guaranty insured $2.78 billion of taxable muni volume, out of the $4.4 billion taxable for the industry. Assured Guaranty also insured an additional $312 million of taxable corporate CUSIP bonds, bringing Assured's total to $3.09 billion of taxable volume.
Assured wrapped $6.04 billion of taxable muni volume out of the reported $10.01 billion for total insured taxable volume in 2020. Assured insured $708.4 million of corporate CUSIP taxable volume, bringing its total to$6.8 billion.
"If the market gets more taxable deals and/or we see some sort of Build America Bond-type structure coming back to our market, we may see more use of insurance," according to Nat Singer, partner and senior managing director at Swap Financial Group. "Taxable buyers, to an extent they are not situated in the same fund family as some of the tax-exempt funds, often don't have the resources to do sufficient credit research in the muni market. With an insurance wrap, they get the benefit of both belts and suspenders on the deal from a credit standpoint as well as an independent blessing on the structure of the deal."
Singer added that as an advisor, he considers the potential use of bond insurance for every deal he works on. It won't work on AA, AAA credits, he said, but he always thinks about it on lower-rated credits because it provides economic benefit to his clients.
And while a recent $275 million deal for the University of California, Davis, on which Swap Financial was the advisor and BAM insured, would have been successful without insurance, Singer said "it was even more successful with insurance."
"For a Baa3 credit demand would have been sufficient to clear the deal at aggressive levels from investors searching for yield," he said. "When we added the insurance, it served to expand the group of investors, giving the issuer even more pricing leverage. Ultimately, the cost of insurance was just a fraction of the incremental spread benefit we saw from upgrading a Baa3 credit to a AA credit."
Singer noted that general credit spreads in the market are driving the potential benefits associated with insurance but it is becoming harder to make insurance work economically, as credit spreads have become so narrow, brought on by the huge demand for tax-exempt bonds.
"When credit spreads widen, insurance will make more sense for more issuers," Singer said.
Cure agreed. "It would help bond insurance if investors start to get concerned about credit issues, as that should provide wider spreads between lower and higher quality credit," Cure said. "The other factor that would help, is if interest rates were to move higher as well as an increase in muni supply."
Bond insurance is "especially beneficial to smaller investors and smaller sized deals as seeing bond insurance provides comfort that someone else is taking a look at structure and credit and signing off on it, other than the underwriters and financial advisors," Singer said.
Cure, noted that while insurance has made some gains, it will "never get back to being 50% of the market," but he believes it can hold onto a market share of around 8% to 9%.
"The viability of the product has shown through and the insurers have strict underwriting practices, as they remain cautious and they are not insuring anything and everything," he said. "The bond insurance product has proven and shown it's worth again but with some credit concern and a raise in interest rates, it could tick up more."
