The municipal bond insurance industry is down, but not out.
At least that’s the view of Kroll Bond Rating Agency, which released a 28-page financial guaranty rating methodology on Wednesday, saying it believes that bond insurance will continue to play a role in the municipal market.
“KBRA believes that the modest market penetration currently experienced by the two active municipal guarantors does not reflect a lack of intrinsic demand for the product, but is due to idiosyncratic factors, such as narrow credit spreads, downgrades resulting in non-economic ratings assigned by other rating agencies, municipal ratings harmonization, which [shrank] the addressable market, and counterparty limits,” wrote Karen Daly, senior managing director and primary author of the report.
In 2008 the market took a steep decline when bond-insured issuance fell to $72.18 billion from $200.45 billion the year before. After the financial downturn, Assured Guaranty Corp. and Assured Guaranty Municipal Corp. had been the only active insurers until last year, when Build America Mutual Assurance Co., a municipal-only bond insurer, opened for business.
The industry may expand to include additional start-ups, as well as a possible resurgence of existing insurers that are now dormant, KBRA said.
Given the losses insurers suffered in residential mortgage-backed securities and collateralized debt obligations, Kroll predicts that most new business volume over the near-to-medium term will probably come from the municipal finance market.
KBRA’s primary focus in its financial analysis is the sufficiency of a guarantor’s claims-paying resources relative to potential claims on the insured portfolio in a run-off. The agency will evaluate the level, quality and liquidity of a guarantor’s investment portfolio as well as its ability to generate additional capital from ongoing operations and recoveries on claims paid.
“History has proven that at the end of the day what policy holders care most about is getting paid when there is a default,” Daly said. “What better way to make that determination than to test a company’s ability to pay claims in a run-off scenario?”
The agency’s financial guaranty methodology includes a review of the guarantor’s ownership structure to understand the sources of commitment capital, the diversity in ownership, and the Board of Director’s influence the company’s objectives. Kroll also looks for a well-developed and executed enterprise risk management plan and weighs the overall risk profile of the portfolio, including sector and geographic factors. This will also include default probability, loss severities, factor weights, and loss simulation when reviewing a bond insurer’s insured portfolio.
“Significant new business challenges or operating losses, which drain financial resources, can constrain the rating,” the report said. “KBRA, however, is aware of the need for a guarantor to manage its business and insured portfolio through different credit cycles, and therefore does not target specific levels of new business volume, market share, earnings or return on equity as part of its rating criteria.”
KBRA said it is unlikely to assign a rating above AA+, at least initially, given the recent past performance of the financial guarantor industry. However, as and when the industry demonstrates a track record of prudent underwriting and sustainable losses, the agency said it can foresee a return to AAA levels for some companies.
No active bond insurers now carry ratings above AA. Moody’s Investors Service rates Assured Guaranty Municipal at A2. Standard & Poor’s rates the insurer at AA-minus. BAM carries a AA rating from S&P.
Fitch Ratings does not rate municipal bond insurers.