Monoline bond insurers that have hit rock bottom are positioned for a rebound that could see them wrapping up to 30% of new issue supply in some ratings groups, Citigroup Global Markets said.
Smaller and medium-sized deals with single-A and BBB ratings will be best suited for insurers as the industry heats up due to competition between municipal-only guarantors Build America Mutual and Assured Guaranty’s Municipal Assurance Corp, Citi said in a report on Thursday. Higher yields on municipals, market volatility and stronger demand from retail investors could prop the industry up from its current all-time low, Citi said.
“We do not think that the glory days will return any time soon, but, in our view, the monoline sector has hit its bottom and is in a recovery mode,” lead writer Mikhail Foux said in the research report.
Insurers wrapped a total of $5.63 billion of the $175.5 billion in new bond issues in the first half of this year, meaning insurers saw just 3.2% of market penetration, compared with 3.9% at this point a year ago. Before the financial crisis, bond insurers backed nearly 60% of new issues. Total penetration into the market could reach 10% over the next few years, Foux said in an interview.
“The monoline sector has moved past its nadir due to reemergence of new players and improved credit quality for some of the old ones,” Citi said in the report. “Moreover, a substantial pick-up in municipal volatility and higher yields strengthen the case for using monoline wraps on certain credits.”
Negative headlines surrounding municipal downgrades and defaults have made markets more challenging for weaker credits that benefit from the enhancement offered by insurers, Foux said. On top of that, competition between BAM and Assured’s MAC will encourage investors by increasing insurance availability and keeping premiums in check. This could be an even more prominent factor with the likely reemergence of MBIA’s National Public Finance Guarantee, which has continued to build liquidity with legal settlements over the past year, Foux said.
“Now you have clean products, clean companies dedicated to the muni market, and that’s the main change that the industry has made,” Foux said. “I think that’s the new model and that will work out relatively well going forward.”
MAC launched in July and wrapped its first transaction, $2.5 million school district deal, just weeks later. Assured said the business will be investing strictly in investment grade credit in risk categories 1 and 2, which includes lower-risk debt such as general obligation bonds, public universities, utilities, and transportation.
“The sweet spot for monolines remains in the low-single-A [and] high-triple-B smaller to medium size deals, which provides the most benefit to issuers and is not very costly from the capital prospective for insurers,” the report said.