Remember when investors questioned whether muni bond insurance was worth it?
It was in the aftermath of the Great Recession and muni insurers had faltered. Several had strayed from their core business – municipal bonds – and made forays into toxic mortgage securities, decimating their credit ratings.
At that point, many investors wondered whether bond insurance made sense. If the firms couldn’t manage their own business, the thinking went, how could they be trusted to perform if called upon?
As it happened, insurers did leave the business and the largest remaining insurer, Assured Guaranty, scaled back.
But that was then. Today, it’s a different story.
As the economy seeks stable footing amid the global pandemic, the mindset of investors and the balance sheet of insurers have made a U-turn.
Issuers looking to lower their borrowing costs and facing possible revenue headwinds are using bond insurance at an increasing clip. In the second quarter of 2020, 7.13% of new issues carried insurance; in the third quarter, the share was 6.8%.
Those figures dwarf the 4.72% average share during the decade before the pandemic.
And the financial health of the insurers?
As we noted (“Leading Muni Insurers Earn Top Marks”), S&P Global Ratings has affirmed both Assured Guaranty and Build America Mutual’s AA rating and stable outlook, the strongest rating the agency assigns to any active muni insurer.
S&P cited Assured’s “excellent capital and earnings,” and after a stress test on BAM’s portfolio, concluded that BAM “may perform better in a stressful economic scenario.”
And their business isn’t coming from just borrowers. BAM said it’s seeing record volume from investment firms aiming to guarantee the bonds they already own.
Muni bond insurance lowers borrowing costs
Muni bond insurers, who are paid a one-time premium, guarantee the repayment of principal and interest over the life of the debt.
Insurance enables issuers to borrow at lower rates than their credit ratings might otherwise allow, while investors who purchase insured bonds are even more confident of payment.
Insurers, though, are rarely called upon. In the $4 trillion municipal bond market, defaults are miniscule.
For individual investors, insurance can be valuable and provide extra peace of mind. But there’s a simple question they should ask before investing in bonds – regardless of whether they’re insured: “How will I be repaid?” That’s the most important thing to know.
Examine the source of revenue that will pay your tax-free income. Focus on quality first, then yield.
This information is readily available and professionals are available to help.