Bond insurers such as MBIA's National Public Finance Guarantee and Assured Guaranty are set to bolster their capital positions on a continuing wave of municipal refundings of guaranteed bonds.
Low-interest rate environments encourage issuers to refund bonds, and with rates remaining low, bonds surpassing their 10-year no-call provisions will propel refundings in 2014 and 2015, analysts and rating agencies said. Insurers reduce risk and take unearned premiums into revenue immediately when bonds are refunded, improving the guarantors’ capital adequacy positions.
In 2004 and 2005, more than 60% of the total $358 and $408 billion of new issue volume, respectively, was insured, according to Bond Buyer data. Even as rates begin to rise, current yields remain lower than in 2004 and 2005, when 10-year Treasuries were at 4.15% and 4.22%, respectively, according to Standard & Poor's. The benchmark 10-year Treasury yield, currently at 2.50%, may rise to 2.91% in 2014, S&P said.
"The legacy bond insurers are currently experiencing this business dynamic of accelerated growth in capital and rapid run-off of risk exposure," Marc Cohen, an analyst at S&P, said in a Sept. 24 report. "As a result, the capital adequacy positions of these companies are improving."
Financial guarantors could insure between 20% and 30% of new issuance in the municipal market, as competition increases and stressed municipalities reiterate the value of insurance, rating agencies and industry leaders have said. High refunding levels, as well as greater capital adequacy and rising interest rates, may contribute to that growth of business, S&P said in its report.
The risk associated with outstanding exposure on insured bonds is eliminated when an issuer refunds the bonds. The process reduces the capital charges associated with an insurer's portfolio and increases statutory capital, said Robert Tucker, managing director of corporate communications at Assured.
"We definitely saw refundings picked up in 2012 and the first half of 2013, as lower interest rates encouraged issuers to refund," Tucker said in an interview. "It does create a stronger capital position for us."
The recent dip back to lower interest rates after a spike caused by a government shutdown and the Federal Reserve's discussion of tapering quantitative easing means issuers may eye more refunds, Cohen said in an interview.
"Issuers who may have missed the market are coming back to take advantage of the municipal yield environment," Cohen said.
Gains in capital positions may enhance insurers' image in the industry, Kevin Brown, managing director of corporate communications at MBIA, said in an interview.
"Capitalization measures, which are important to regulators and rating agencies, improve due to the increase in capital and surplus and corresponding decrease in insured exposure," Brown said.
The universe of insured bonds is comprised mostly of pre-2008 bonds that will mature before most uninsured bonds, Municipal Market Advisors said in an Oct. 15 report. Most of those outstanding insured bonds will become callable in the next four years, according to the report.
"Our takeaway here is that the insurers do stand to benefit financially in the medium term from rapid exposure refundings," MMA said.
Heavy refunding volumes, however, will cut market liquidity as fewer insured bonds remain in circulation, according to the MMA report. As a result, the monoline industry may have difficulty reclaiming market share and penetration over time, MMA said.
"On the downside, refundings reduce an annuity-like revenue stream for the insurer which must be replaced with new writings," MBIA's Brown said.
From a trader's perspective, scarcity of insured bonds could drive demand for that product, Adam Buchanan, vice president in Zeigler's sales and trading desk, said in an interview.
"With their legacy portfolio turning over it creates a scarcity of insured credits and provides additional capital for them to do new business," Buchanan said. "When insured bonds are refunded insurers realize unearned premiums providing them the opportunity to deploy risk and expand market share."
The perception that insurance has made investors whole in distressed municipalities has increased the demand for insured paper in the municipal market, Buchanan said. Insurers taking advantage of newly freed capital could appear in new places in the market.
"One thing that makes insurers relevant is when they show up frequently in the primary market, where you can easily track the trading value they provide," Buchanan said. "As an insurer's legacy portfolio gets refunded it gives them capacity to add market share and show up on new previously uninsured credits."
Issuers that choose to refund in a low interest rate environment can choose to come to market without insurance, or get a different policy on the new deal.
"If they decide to utilize the same insurer going forward, the insurer will add some risk back on, which could be less given lower interest rates," Cohen said. "If the guarantor is able to insure the new policy that is another source of capital they'll receive."
