Bond insurance executives made the case Wednesday that demand for their product still exists despite numerous headwinds that have reduced the insurable world of new product and created uncertainty among buyers.
According to Thomson Reuters, bond insurance in the first 10 months of this year totaled $12.2 billion, or 5.3% of the $229 billion floated this year. For the same period last year, 6.8% of the market was insured, or $23.4 billion.
One reason the percentage of insured deals has failed to improve recently was the decision by two rating agencies to recalibrate muni ratings onto a global scale. That raised the credit scores on thousands of muni issuers, giving them less incentive to purchase credit enhancement through the bond insurers.
However, Moody’s Investors Service released new statistics Tuesday showing that downgrades outnumbered upgrades by a margin of 5.3 to 1 in the third quarter — the highest ratio of the financial crisis.
“With the downgrades, the accessible market is going to get bigger,” said William Hogan, head of public finance at Assured Guaranty, speaking at the Bloomberg State & Municipal Finance Conference in New York.
Hogan called the sweet spot for insurance the A-rated business, and noted Assured’s two platforms — the only ones still wrapping new munis — insured more than 1,000 transactions this year, including roughly 40% of all single-A rated deals, or 18% of single-A deals by volume.
Assured also strengthened its balance sheet in an out-of-court settlement with Bank of America Merrill Lynch in April. The bond insurer received more than $1.1 billion of cash from the deal.
Another boon is that spreads between single-A and triple-A munis are around 100 basis points, whereas pre-crisis they were less than 40, Hogan said.
Premiums for insurance are paid based on the savings spread between underlying and enhanced ratings. A higher spread gives more room for profit, and more incentive for the issuer to buy insurance.
But three issues are holding back investors from feeling comfortable about buying insurance.
The first stems from the viability of the guarantee. Assured has never reneged on a promise to pay principal or interest, but Ambac Assurance Corp. — once the second-largest bond insurer, but now a junk-rated entity with a bankrupt parent — created uncertainty in March 2010 when it split its portfolio of insured debt into two accounts.
Defaults in the healthy account, which includes the vast majority of its municipal debt portfolio, have continued to be paid in full. But Ambac’s regulator, the Wisconsin Office of the Commissioner of Insurance, created a segregated account to deal with riskier credits. Roughly 700 policies with a net par value of $35 billion were placed in this account, temporarily frozen, and dealt with independently so Ambac wouldn’t pay claims on a first-come, first-served basis until it became insolvent.
The bulk of these credits were structured finance, but $452 million of Ambac’s exposure to the Las Vegas Monorail, which entered Chapter 11 bankruptcy in January 2010, was also placed in the account.
The chances might be slim that something similar happens in the future, but the precedent isn’t heartwarming for investors. Secondly, Assured has long exposure to municipal debt, and the market simply doesn’t know what the future holds in terms of defaults. If the past few decades are a guide, this shouldn’t weight on investors much, but financial turmoil of recent years calls that reliance into question.
However, muni defaults have been in decline this year, and Robert Kurtter, managing director at Moody’s, even noted that defaults among nonrated bonds — a market characterized by weaker credits — are significantly down, with just 16 cases year-to-date.
A third concern is that Standard & Poor’s is in the midst of implementing harsher capital and leverage requirements for the bond insurers, so maintaining high credit scores has become more difficult.
One uncertainty not considered a threat is the possibility of new insurers entering the market. Hogan said it’s difficult for entrants to raise money, attain ratings, and turn a profit. And if a new entrant does succeed, it simply would validate the product.
