This year will be a pivotal one for for municipal bond insurers, but so far the outlook is negative, Moody’s Investors Service said in an industry outlook released yesterday.

Insured bonds routinely covered more than 50% of new issuance in the years leading up to the credit crisis, but most guarantors were downgraded when the structured-finance products they backed laid waste to their balance sheets.

Last year only 8.7% of new issuance was insured, and virtually all of the ­business was done by a single company, Assured Guaranty Ltd., through its ­subsidiaries Assured ­Guaranty Corp. and Assured ­Guaranty ­Municipal Corp., according to Thomson ­Reuters.

No rebound has yet been seen in 2010, and according to Moody’s it is “somewhat premature to consider the industry as having reached a recovery stage.”

Moody’s ratio of upgrades to downgrades last year was the lowest in more than two decades. The agency also expects the impact of the recession to cause fiscal strain for the next 12 to 18 months, which means finding a bottom in the market any time soon is unlikely.

Further, it remains uncertain exactly how large capital losses from mortgage-related exposures will be, and as a result, market confidence in the insurance product has continued to weaken.

Other challenges include limited liquidity, litigation risks, and regulatory uncertainty.

However, some positive signs do exist, the report pointed out.

“What we’re highlighting is that despite all the troubles so far, there is still some demand for the product,” co-author Stanislas Rouyer, senior vice president at Moody’s, said in an interview.

One sign is credit spreads. In January 2009 the credit spread between Baa-rated and Aaa-rated munis was around 150 basis points, whereas last month it was closer to 200 basis points, Moody’s noted. The wider spread gives issuers — particularly smaller or higher-risk issuers — more incentive to buy insurance and sell debt at a lower borrowing cost.

On the negative side, those spreads have tightened in recent weeks, potentially threatening the guarantor’s pricing power and profitability.

Another signal that market confidence could improve is that Assured has been active in the market despite not having a triple-A rating from Moody’s.

“Assured’s ability to write substantial new business has illustrated the market’s acceptance of a financially strong guarantor with a higher risk profile, albeit clearly the firm has also benefited from currently limited supply of bond insurance,” the report said.

Co-author Helen Remeza, a senior analyst at Moody’s, noted there was also market appetite for new entrants in the market, despite their lack of track-records and potentially initial skepticism from market participants.

BondModel Co, a New York-based outfit founded by former bankers from Goldman, Sachs & Co., and Municipal Infrastructure and Assurance Corp., backed by a number of financial institutions, both plan on entering the market this year.

Another potential positive for insurers is the talk of an increase in municipalities defaulting this year, which spotlights the desire of issuers to have a guarantee for their debt service.

The potential for the cash-strapped Harrisburg, Pa., to miss a March 1 debt-service payment of $2 million has, “on a net basis, been seen as a positive” for the insurance industry, Rouyer said.

“Clearly, if there is very significant deterioration in a very large credit of a guarantor it would hurt the guarantor,” he said. “But marginal stress in the sector, I think, on a net basis, is probably beneficial to the guarantors, because the more investors are concerned about their investments and the more they think they need protection, the more the guarantors can add value.”

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