As reported recently in The Bond Buyer, on Dec. 17, 2008, a blue-ribbon commission submitted a report on municipal credit enhancement to the National League of Cities. The commission recommended that municipal issuers consider creating a mutual insurance company to insure new, fixed-rate municipal debt.
The commission's goal is laudable: to reduce financing costs for issuers by addressing the current lack of credit enhancement products. Having founded the municipal financial guarantee industry in 1971, Ambac shares this goal.
There are currently 35 state credit-enhancement programs rated by Standard & Poor's. Of these, only six are rated AAA, while 12 are rated lower than AA. The ratings of most of these programs are directly linked to their sponsoring state's ratings. Many are charged with supporting narrow public policy mandates and have limited capacity.
The NLC report also identifies state pension plans as potential sources of capital for a mutual insurer. While state pension plan assets are enormous, such plans owe a fiduciary duty to their beneficiaries. They are not, nor should they be, instruments of public policy, which would present clear conflicts for such pension plans.
The NLC report presents evidence that municipal bonds have a low default rate. This has certainly been the case in recent years. However, this does not mean municipal bonds are riskless, nor are historical default rates necessarily good predictors of future default rates.
Given that the current stressed credit environment seems to continuously present us with new reasons not to take stability for granted, historical default-rate data isn't necessarily enough of an incentive to attract fresh capital from investors seeking asylum in low-volatility instruments. Furthermore, today's municipal market has expanded and encompasses lease revenue bonds, health care, transportation, economic development, infrastructure projects, and higher education.
A further problem with default statistics is that they do not capture the many issues that avoided default due to the active remediation efforts of financial guarantors. Jefferson County, Ala., with $3.2 billion of insured sewer debt, is a prime example. Bondholders continue to receive interest and principal while the insurers and others work on a solution to the county's fiscal problems.
Issues affected by Hurricane Katrina offer another good example of the value of bond insurance. Many billions of dollars of municipal issues felt the effects of the storm. Bond insurers devoted considerable time and resources to assisting affected issuers. All the while, holders of insured bonds never missed a payment.
We do not mean to overstate the risk in municipal bonds, but rather to highlight that insuring municipal debt is not risk-free. This is precisely why financial guarantors are needed and why a mutual insurance company owned by municipalities does not present a solution as much as it potentially creates a new layer of risk.
The problems are twofold. First, the evaluation, pricing, and remediation of specific risks must be unbiased and completely independent of any political pressures. It is hard to imagine a municipal-owned insurer not being subject to pressures from its members, particularly in connection with loss-mitigation efforts.
Second, one needs to ensure that one attracts the best management, underwriters, and risk professionals to run a municipal insurer. This would be difficult for a company owned by issuers. While we do not disagree that new municipal credit enhancement capacity is needed, issuers should be as concerned with the intellectual capital provided by their guarantor as with the enhancement they seek to gain.
While a mutual insurer could provide needed capacity, we believe that properly managed, private market solutions would best serve the public interest.
Douglas C. Renfield-Miller
Chief executive officer
Everspan Financial Guarantee Corp.
(Editor's Note: Everspan - formerly known as Connie Lee Insurance Co. - is a wholly owned subsidiary of Ambac Assurance Corp.)