National Public Finance Guarantee got a vote of confidence from Kroll Bond Rating Agency a week after S&P Global Ratings put the MBIA Inc. municipal bond insurance unit on credit watch negative.

KBRA issued an opinion on Tuesday that defended the stress test it used in affirming its AA-plus rating on National on April 28, arguing that bond insurance financial strength ratings should be "heavily focused on an assessment of the likelihood a financial guarantor will meet all its obligations to policyholders when claims come due." In its report last week, S&P put the ratings of National and Build America Mutual on watch saying it might downgrade the insurers "based on a company's competitive strengths or weaknesses relative to its peers.”

S&P said it might drop National's AA-minus rating three levels and BAM's AA rating by one notch. National is third largest muni bond insurer after Assured Guaranty Ltd. and BAM, which Kroll doesn't rate.

Paul Kwiatkowski, managing director, KBRA
Paul Kwiatkowski, managing director, KBRA

In affirming National's rating, KBRA used a Monte Carlo analysis for nearly all of National’s insured portfolio and a deterministic loss assessment for the company’s exposures to Puerto Rico and a limited number of other distressed credits. KBRA tested National’s ability to pay this stress level of claims, and other expenses, in a runoff scenario. In the test, National satisfied all projected loss amounts due with a "comfortable" balance remaining, Kroll said.

“In the past, overly proscriptive rating agency criteria which explicitly incorporated assessments of market share, business lines, or competitive position fostered behaviors detrimental to the credit profile of the entire financial guaranty industry,” Kroll said in the report. “This scenario unfolded just under ten years ago, when financial guarantor companies, pressured in part by legacy rating agency expectations, reached for business that was not truly creditworthy. Many of those companies are now in run-off and their insured bondholders suffered losses.”

KBRA said it believes that finding a given level of growth inadequate at a particular company and favoring certain business initiatives over others, can have the domino effect of pushing bond insurers into seeking riskier business at unattractive returns.

“In KBRA’s opinion, the legacy rating agencies do not have a favorable track record when it comes to steering bond insurers in and out of specific business lines. KBRA has never taken this approach as noted in our methodology.”

The report went on to say that municipal bond investors are all too familiar with the ratings risk of financial guarantors following the dramatic downgrades during the credit crisis. “A rating action on any bond insurer will apply to all securities wrapped by that financial guarantor. Therefore, rating actions on bond insurers will impact a large number of fixed income investors across broad sectors of the municipal market.”

KBRA said that it believes that rating agencies should evaluate risk, not promulgate a potentially risky business strategy.

Matt Fabian, partner and Municipal Market Analytics said that investors buy bond insurance because of the insurers’ claims paying ability, not because of their market share.

Matt Fabian, managing director at Municipal Market Advisors.
Matt Fabian

Both National and BAM "can make good arguments that policyholder security has been improving, not getting worse,” he said. “S&P is penalizing these companies for not being able to capture spread at a time when spreads are at or near all-time tights and spread-based strategies are (almost) universally struggling.”

KBRA noted that as of March 31, National had an insured municipal portfolio of $99.1 billion of net par and claims paying resources of $4.1 billion.

“In KBRA’s view, the profitability of relatively small amounts of new business does not have a material impact on National’s ability to meet policyholder claims. In addition, KBRA’s opinion is that National’s substantial balance sheet and declining leverage offset concerns about lower-than-expected production. On the other hand, for a newer entrant, without a substantial legacy portfolio or balance sheet, KBRA believes a focus on business volume, pricing, and capital structure may be appropriate.”

KBRA said it will continue to emphasize ability to pay in its credit analysis of the financial guarantors it rates.

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