A reincarnation of the Build America Bond program would be another credit negative for bond insurer Assured Guaranty Ltd, according to Moody's Investors Service.
The rating agency said President Obama's Feb. 14 proposal to revive the BAB program on a permanent basis with a 28% federal subsidy would "effectively shut out" a portion of the insurable market. That would hurt Assured, the only active bond insurer, and possibly force inactive insurers such as National Public Finance Guarantee Corp. to "reevaluate their business plans."
The BAB program gave issuers the option of tapping into broader fixed-income markets and last year caused traditional tax-exempt issuance to fall to its lowest level in a decade. That shrunk the market of tax-exempt bonds eligible for insurance, and the bonds that did get issued were in less need of credit enhancement because the diminished supply caused borrowing costs to decline.
Taxable bonds can be insured, but Assured was able to wrap less than 2% of BABs because they were often highly rated and sold to cross-over buyers unfamiliar with credit enhancement.
In addition, as Moody's analyst Myra Shankin explained in a weekly credit outlook published Tuesday, the cost of bond insurance is excluded from the federal subsidy calculation, so insurance is less economical for taxable issuers.
Since it became clear in mid-November that the BAB program would expire on Dec. 31, Assured has struggled to take advantage of the opportunity presented by a kick-up in borrowing costs for issuers.
In the first seven weeks of 2011 it wrapped 90 deals worth $862 million, or 3.8% of issuance, according to Thomson Reuters. Last year, it wrapped $22.86 billion of municipal bonds, or 6.2% of total market issuance.
Those single-digit penetration rates compare with the pre-crisis days when more than half of all issuance was insured by eight competing guarantors. The dwindling penetration results in part from the negative stigma attached to bond insurers since most of Assured's competitors got wiped out during the credit crisis.
Assured's target market is single-A issuers, but unless the company is upgraded from its current double-A range or investors begin giving more weight to credit enhancement, it will be hard to offer borrowers significant savings. An average 10-year insured bond yielded 4.11% last week, according to Municipal Market Data. That is 95 basis points higher than the triple-A scale and reflects a savings of only 14 basis points from the single-A scale.
Assured's platforms are currently rated Aa3 by Moody's, each with a negative outlook. A downgrade would leave the insurers with an A1 rating at best.
Standard & Poor's rates Assured two notches higher at AA-plus. But last month it proposed new ratings criteria which could lead to investment-grade insurers being downgraded "by one or more rating categories."
A revival of the BAB program, in combination with a change in ratings methodology, could leave the municipal market bereft of highly rated bond insurers for the first time in decades.
An Assured spokesperson declined to comment, but placed focus on the final two paragraphs of the Moody's report. These point out that smaller or less-frequent issuers that have difficulty accessing capital markets will probably have difficulty issuing BABs and will most likely use bond insurance instead.
Moody's concluded by noting that Obama's proposal is "far from finalized" and could face strong Republican opposition.