Low interest rates, a slow recovery from the financial crisis, and a shrinking pool of its target market make for a less than ideal environment for municipal bond insurers.
In such conditions, the industry continued its steady contraction in 2012, with the total amount of long-term insured bonds decreasing by 13%. Total issuance decreased to $13.27 billion from $15.26 billion in 2011, according to Thomson Reuters data. In the broader market, however, issuance increased to $376.24 billion from $287.8 billion last year.
“There are at least two factors,” said Stanislas Rouyer, an associate managing director on the specialty insurance team at Moody’s Investors Service. “One is low interest rates, which makes insurance less attractive to investors. A second is that it’s an industry that suffered tremendously following the financial crisis and at some level there is greater skepticism about the value of bond insurance, and that is also contributing to the decline.”
The industry took a steep decline in 2008, when issuance fell to $72.18 billion from $200.45 billion — a 64% decrease. In 2005, insurers backed 57% of the market. Last year, they backed only 3.5%.
“Also, the target market is narrower today. It tends to focus on single-A and triple-B rated municipal paper, which is a smaller universe than companies like Assured targeted in the past,” Rouyer said.
Analysts at Municipal Market Advisors have also cited the low interest rates and the smaller pool of eligible issuers as some of the industry’s problems.
“The insurers have indeed struggled to replicate anything like historical penetration statistics, challenged not only by Assured’s looming downgrade itself, a persistent lack of demand by many institutional buyers, the far more limited role being played by direct retail in the current market, the effective end of new VRDO/ARS issuance four years ago, and all the baggage coming with the near complete collapse of the legacy insurers,” MMA managing directors Matt Fabian, Lisa Washburn and Robert Donahue wrote in a recent report.
Years ago there were several municipal bond insurers, but the financial downturn left Assured Guaranty Ltd. as the only active insurer.
Through its subsidiaries, Assured was responsible for almost all of the insured bonds in 2012. Assured Guaranty Municipal wrapped 1,157 issues totaling $13.23 billion in 2012. In 2011 AGM insured 1,193 issues totaling $14.97 billion. Assured Guaranty Corp. wrapped two issues last year totaling $13.7 million.
Robert Tucker, managing director of investor relations, said Assured Guaranty has “always remained focused on credit quality and pricing discipline, and targeting or maintaining a specific share of the new issue market is not what drives [their] underwriting decisions.”
Looking just at the insurer’s target market, Assured Guaranty was used on 31% of underlying single-A-rated transactions sold and 12% of the related par in the first nine months of 2012, according to the company’s most recent financial results, released during the third quarter.
“This demonstrates the fundamental demand for our guaranty and shows the value and importance of our insurance,” Tucker said.
He also noted that in the secondary market, Assured Guaranty issued 610 policies during 2012, which represented an additional $1.3 billion of par.
On top of the already challenging environment, Assured spent nine months of 2012 on review for downgrade by Moody’s Investors Service. Tucker said that, combined with historic low interest rates and tight credit spreads, the rating uncertainty contributed to a reduction in the use of insurance.
“The uncertainty caused by Moody’s especially affected Assured Guaranty’s business opportunities related to refundings, which are more sensitive to interest rates and timing, and on larger transactions,” he said. “This reduced Assured Guaranty’s market share from a par perspective.
After the long wait, Moody’s finally downgraded AGM in January 2013 to A2 from Aa3, citing a decline in insurance usage, modest profitability and still-meaningful legacy risk. However, the agency noted that the insurer’s capital adequacy remained strong.
Alan Schankel, managing director at Janney Capital Markets, said the downgrade will likely make the business environment even more challenging for Assured, but he noted that it still has a strong capital position.
“We believe Assured is well capable of covering its municipal obligations in future years, and if and when interest rates begin to move higher, the basic business model should strengthen, perhaps enough to justify rating upgrades,” he said.
Both AGM and AGC carry AA-minus ratings from Standard & Poor’s with stable outlooks.
For the first time in years, Assured was not the only active bond insurer last year. While it wrapped 99.8% of the market share, a new credit enhancer entered the picture, taking the remaining 0.2%.
Build America Mutual Assurance Co. launched in July 2012 and wrapped its first deal in September. BAM insured three additional deals during the remainder of the year for a combined total of $28.7 million.
Seán McCarthy, managing director and chief executive officer of BAM, believes there is a demand for bond insurance “from an insurer that is first, municipal-only with a clean balance sheet, and second, a mutual, where the issuers insured are members.”
“Importantly, the mutual structure eliminates the conflict between a stock company’s desire to return capital to shareholders and policyholders’ desire for maximum capital retention against non-investment-grade transactions that could potentially default,” McCarthy said.
Standard & Poor’s, which rates the new insurer at AA with a stable outlook, calls the unique mutual structure a strength, saying it may provide risk-profile stability and thus support BAM’s ability to issue new insurance policies competitively during and after periods of stress. Moody’s does not rate the insurer.
McCarthy said he believes their success will stem from the mutual structure, which allows BAM to carry more capital than a stock company would, without pressure to continually expand volume and earnings from their pledge to provide the market with transparency.
Among other credit enhancement sectors, letter of credit-backed bonds in 2012 also saw a decline from 2011. Last year, LOC-backed bonds totaled 115 issues worth $6.08 billion. That’s a 38.6% decrease from 2011, when there were 184 issues totaling $9.9 billion.
Guaranteed bonds, however, saw an increase last year when a total of 1,675 issues worth $28.08 billion were guaranteed, following 1,253 issues totaling $19.55 billion in 2011.