HRF Associates' comprehensive plan (Monitor Assurance Corp.) to address the liquidity and credit needs of the municipal market has drawn comparisons to a plan offered by the National League of Cities. HRF detailed its plan with the NLC in January and it appears that some elements have been incorporated into their proposal. However, there are significant and fundamental differences in the plans' approaches to underwriting and risk management, reliance on federal involvement, and federal exit strategy.
According to market sources, approximately 8,500 of the more than 55,000 municipal issuers are rated by the rating agencies with the remainder being comprised of smaller, less-frequent issuers. The NLC plan limits the firm's risk appetite to only those municipal bonds rated investment grade by the rating agencies. HRF's proposal calls for creation of a company with the capital strength to assist large issuers and the expertise and willingness to consider underwriting essential government purpose municipal issues such as general obligation, tax-backed, hospital, education, water and sewer, road, bridge, etc., for smaller and infrequent issuers as well. Monitor considers a small, well-run, rural hospital 100 miles from the nearest competitor to be an insurable risk and an issuer generally in need of the market access that a financial guaranty company should provide.
The NLC plan contemplates a total staff of 30 people who would then process approximately 800 insured transactions per year with underwriting and pricing-decision authority residing at the Board of Directors level. Monitor Assurance will dedicate staff of more than 50 professionals exclusively in the underwriting and surveillance functions in the first year to insure an estimated 1,400 transactions. Underwriting and pricing decision authority will rest with an in-house senior credit committee with the Board of Directors providing oversight.
Beyond the obvious size comparison, within the NLC and Monitor plans is a more fundamental difference in approach, namely the proposed degree of reliance on the federal government for ongoing credit support. Capitalized at $5 billion, the NLC plan requires the creation of a federal reinsurance program in order for the company to insure transactions of larger issuers.
However, the proposed federal reinsurance program is set to expire after only five years. This reliance on federal government backing will lead to confusion in the public's mind as to whether the NLC-led company is an implicit government-sponsored enterprise. Monitor Assurance, with $25 billion in capital, is clearly an entity that can assist both large and small issuers without relying on external reinsurance from the federal government or other, less reliable, third parties.
A key element in the HRF proposal is an almost immediate start to the repayment of the initial $25 billion equity provided from the federal government. After a period of five years we conservatively estimate that more than $7 billion of the initial equity will be returned to the Treasury, and alternatives exist which could dramatically increase that amount. The NLC plan is structured with an initial equity stake of $3 billion and two follow-on federal equity infusions of $1 billion each in the first five years. However, the plan contains neither a formula nor a schedule for repayment of the initial or follow-on federal contributions. This only serves to reinforce the notion that the NLC approach is an implicit GSE.
Our objective is to create a national platform with superior capital strength, capable of assisting both significant issuers as well as small and infrequent market participants in their financing needs, balanced by effective risk management and rapid return of initial capital to the Treasury.
Robert M. Smith
Executive Vice President
HRF Associates LLC
HRF Associates LLC is a consulting services firm with offices in California, Colorado, and New Jersey. It specializes in financial guaranty, risk management, rating agencies, and regulatory issues.