Radian Group and its financial guaranty subsidiary, Radian Asset Assurance, has partnered with the National League of Cities to explore the formation of a what would be the first-ever public finance mutual bond insurance company.

According to the NLC, the company would aim to provide bond insurance to municipalities at the lowest cost in response to demand it saw in the marketplace, the group said.

The announcement comes on the heels of Standard & Poor’s releasing its new bond insurance criteria, and threats in Washington to take away tax-exemption from municipalities, which has the potential to raise borrowing costs. It also follows failed attempts by Radian Asset Assurance to penetrate the bond insurance world again.

The junk-rated bond insurer was compelled to stop writing public finance guarantees in fall 2008 so it could prop up sister company Radian Guaranty, a mortgage insurance business. Radian is rated Ba1 by Moody’s Investors Service and BB-minus by Standard & Poor’s.

In February, Philadelphia-based parent Radian Group bought Municipal and Infrastructure Assurance Corp., the muni-bond insurer shell company that Macquarie Group had struggled to launch since late 2008. The deal closed in June and was purchased by Radian for $82 million.

It’s not clear how the new mutual company and MIAC would fit together, if at all. David Beidler, president of Radian Asset Assurance, said: “We are at the beginning of the process and we are extremely hopeful that our ownership of MIAC shell will shorten the amount of regulatory time necessary to launch a company.” He declined to comment further.

Donald Borut, executive director at the NLC, which claims more than 1,600 municipalities as members, said three years ago he formed a committee to brainstorm what could be done to improve the market and availability of muni insurance, and after speaking with governments, regulators and others, the league came up with this new concept for bond insurance.

Borut didn’t comment on a specific timeline for the launch, but said the process to line up private investors — the company’s first goal — could take months. NLC and Radian are seeking private capital for the initial investments, which they hope will then entice issuers to join up.

As a mutual, the company would be owned by issuers who pay for insurance and make payments into surplus notes. “The idea is that the cost for providing this insurance, including the surplus notes, would be more competitive than what is available through other companies,” Borut said.

Radian’s Beidler said the new company would focus solely on public finance, something that sets it apart from bond insurers in the past. Making sure that the issuers of the municipal bonds are owners helps assure bondholders and investors that the company won’t deviate from its public finance mission.“That’s the fate that befell much of the financial guaranty industry,” Beidler said. “They started in public finance, but it was structured finance that caused all the problems. So the mutual structure helps to address that and assure stakeholders it won’t happen again.”

The new outfit would also set up certain filters borrowers will have to pass through. When issuers first approach the company, there will be an initial assessment done by the management company, followed by approval by the mutual company, which guarantees “a structure that is really carefully managed and has multiple ways of ensuring credit worthiness of an issuer,” Borut said.

He said the new company would also discuss the legal structure, infrastructure and licensing process. It will need to talk to regulators and eventually, rating agencies. “Ultimately, this will be viable because we will get a rating that makes it a trusted, viable company,” Borut said.

But the rating environment for bond insurers is in flux right now. Standard & Poor’s is evaluating rival bond insurers MBIA and Assured Guaranty with the new rating criteria in November.

And the pressure for Radian and the NLC is no different. “The other bond houses lost their ratings and this has to have ratings that are so high that it is attractive, not only to the issuers, but to those who put up money,” Borut said.

The ideal is to receive a triple-A rating. “We believe that with what Standard & Poor’s has put together, we can develop a program that fully meets the criteria,” he said. “We have reasons to believe after talking with regulators that this is something that’s viable and attractive. And we’ve had discussions with those who would want to put up capital, and they believe there is a market for this investment.”

Radian’s Beidler added that while new bond insurance criteria by S&P makes achieving a triple-A rating more difficult than it was before, he has been studying the new criteria quite closely and hopes to get the highest ratings possible.

Rodney Clark, deputy chairman for global insurance criteria at S&P, said the rating agency has been aware for a long time that the NLC had a desire to establish a muni bond insurer.

Clark declined to comment on specific ratings, saying only that there are other parties the rating agency has heard from as well that are looking to start up bond insurers in the market due to a perceived need for new capacity. “So these would likely be seen as positive developments towards moving forward,” he said.

The penetration rate for bond insurance is also down drastically this year, possibly creating a problem for the new company. For the first half of 2011, bond insurance was down over 53% from the first half of 2010. About $6.4 billion of bonds were insured for the first six months of this year compared with $13.6 billion in bonds for the first half of last year.

While part of the low levels of bond insurance can be attributed to lower volume in the primary market this year, others say bond insurance isn’t relevant anymore.

Beidler disagrees. “We do think there is a market for this,” he said. “That is part of what the NLC brings to this equation. Its members have been pretty clear in a few instances that there is a need for bond insurance in the muni finance market.”

“Right now, this is totally new,” Borut said. “There has never been a mutual bond insurance company and that’s what makes this concept different.”

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