Bond insurers struggled, germinated and went to court in the first half of 2012.
Assured Guaranty Ltd., the one remaining active bond insurer, started the year in a seemingly strong position. The insurers have to maintain high ratings in order to attract business and Standard & Poor’s had completed a 10-month review process by giving Assured a AA-minus with a stable outlook. Assured’s stock had gone up 46% from a trough in early November.
However, on March 20, Moody’s Investors Service put Assured on review for a downgrade. From a peak in mid-March, Assured’s stock would generally slide downward, and was down 26% as of Aug. 16.
Almost certainly as a consequence of the Moody’s review, Assured’s coverage rate of bond issuance declined in the second quarter. While the first-quarter insured rates by par value in 2011 and 2012 were roughly the same, 4.8% in 2011 and 4.7% in 2012, they had slipped markedly in the second quarter. While it was 5.9% in 2011, it was 3.5% in 2012.
Referring to the impact of Moody’s placement of Assured on review for a downgrade, Assured spokeswoman Ashweeta Durani said in June, “It is sort of like [when] the runner runs a little bit slower when his leg was hurt.”
In early August, Assured released a statement that said: “Our first-half 2012 insured par volume increased in comparison with the first half of last year. Further, for this year, our par volume was higher in the second quarter than the first. We consider this a good result in light of the unprecedented low interest rates, which continued to decline throughout the first half and, along with tighter credit spreads, are driving some investors to forgo insurance in search of every basis point of yield. Assured Guaranty remains focused on credit quality, pricing and risk management. Market share has never been a driver of our underwriting approach.”
On April 13, Assured put out a 16-page statement arguing against a possible Moody’s downgrade.
In the spring, Moody’s released two reports casting the bond insurance industry in a negative light.
While Moody’s reviews usually lead to action within 90 days, as of Aug. 16 Moody’s had not yet taken action on the review. Following its standard practice, Moody’s has declined to explain the review’s status.
Though Assured was the only insurer actively wrapping new bonds in the first half, other bond insurers were active in other ways.
In 2011, Robert Cochran and Seán McCarthy took steps to found a new bond insurer. In the first six months of the year, they had discussions with rating agencies and New York’s insurance regulator about the venture. The discussions led to the launch of Build America Mutual Assurance in July.
Before the 2008 financial crisis, there were several active bond insurers. Their involvement in insuring mortgage-backed securities and the explosion of mortgage non-payments in the downturn led all except Assured to lose their strong ratings. And without strong ratings, they could not insure new bonds.
What they could do was sue those who had hired them to insure the mortgage-backed securities. The insurers claimed that the quality of the mortgages underlying the securities had been misrepresented to them.
In the first half of 2012, Assured sued UBS Real Estate Securities and JPMorgan. Bond insurer Ambac Assurance Corp. sued JPMorgan and Bank of America Merrill Lynch. All of the suits concerned mortgage-backed securities.
To deal with the financial challenges facing Ambac, the Wisconsin insurance commissioner’s office created a segregated account to hold Ambac’s poorly performing assets. In June, a Wisconsin court approved of Ambac paying 25% of claims on the segregated account.
Also in June bond insurer FGIC asked New York State to take it over and oversee a rehabilitation of the company.
Of all the legacy bond insurers, MBIA Inc. had the most active season in the courts.
Early in 2009, New York approved the split of MBIA into two companies, one which would specialize in municipal bond insurance. A few months later, several financial firms sued MBIA, seeking a reversal of the transformation. The case finally went to trial from May 14 to June 7. As of Aug. 16, the judge had not released a decision.
MBIA has its own suit against Bank of America Merrill Lynch, concerning alleged fraud in mortgage-backed securities. The suit advanced slowly in this year’s first half. It is in expert discovery phase, leading up to a summary judgment motion briefing in September.
Bond insurance is not the only one-time fixture of the municipal bond market to see its share of the business decline in the last few years. Another area of the bond market that has seen a decline is variable-rate bonds, which are usually supported by bank letters of credit.
Up until 2007, variable-rate bonds were about 15% of all long-term bonds, by par value. However, they have been in decline since 2009. The percentage of long-term bonds by par value with variable rates has slipped to 7.8% in 2011 from 10% in 2009 and to just 2.8% in the first half of 2012.
Several factors have led to the decline in variable-rate issuance. Low interest rates have made long-term fixed-rate bonds attractive, said Moody’s senior analyst Robert Azrin. Also, some issuers have substituted direct loans from banks for variable-rate demand bonds.
Some European banks that were active in VRDBs have been downgraded or have exited the public finance business, a professional at a major U.S. investment bank pointed out. This has pushed VRDBs’ interest rates up, making them less attractive.