Why Muni Insurance is Making a Comeback

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

Is bond insurance worth it?

Fair question.

After insurers were rocked by bad bets on risky debt back in 2008, incredulous investors questioned the value of insurance.

What’s the point, they wondered, of investing in bonds insured by  companies who so badly mismanaged their own finances?

Once common in the market

It wasn’t always such. Prior to the Great Recession, firms were rock solid and bond insurance was common, covering about half of all new issues. In the wake of the financial calamity, however, that number plummeted. Fast-forward to today, and it’s a different story again.

In high-profile fiscal problems involving Jefferson County, Ala., and Stockton, Calif., insurers stepped up, making good on their obligations. They have also served as the de facto voice of investors during negotiations with distressed issuers. As a group of Bank of America municipal research strategists told Barron’s, insurers “served as a unified representative whose motivation to maximize recoveries aligned with bondholders.”

Strayed from core business

Monolines, as these companies are known, insure or “wrap” bonds, lending their credit ratings to issuers. Traditionally, their bread-and-butter business was in munis where, with miniscule default rates, they thrived. Later, however, they delved into more risky corporate securities. When those ran into trouble, the companies’ own credit ratings suffered, hampering their ability to continue. Some even failed.

Today, that trend is reversing. Though down from their once-lofty heights, the number of wrapped bonds is growing quickly. This year, more than 5% of munis carry insurance, up from 3.2% last year and the highest in five years, according to Bloomberg. Some analysts expect it to climb to 10% in a few years.

“Nowadays monoline insurers play a smaller role,” according to Citi, “but their market penetration has been growing over the last several years, helped by higher market volatility, as well as several high profile credit events and by the growing realization that a handful of insurers provided a solid credit backing for many new issuers.”

Currently there are three monolines: Assured Guaranty and National Public Finance Guaranty Corp., which were upgraded by S&P this year, along with the newly created Build America Mutual.

Improving profile

Investors holding insured Detroit and Puerto Rico bonds need no convincing about the value of insurance coverage. Insured debt from those issuers has bolstered their value while their uninsured counterparts suffered.

Additionally, Moody’s earlier this week gave a shot of confidence to holders of insured PREPA debt. The ratings agency said MBIA (National) and Assured would be able to absorb possible losses on debt issued by Puerto Rico’s power authority.

“Our scenario analysis suggests minimal pressure on the credit profile of all the rated guarantors in the event of a loss severity of up to 50% if the electric authority, PREPA, was to default,” said Brandan Holmes, a Moody’s vice president.

Several years ago, when bond insurers ventured into unchartered waters, they paid a price. But the knee-jerk reaction of some who responded by questioning their very existence was equally ill-advised. Though rarely called upon, the value of bond insurers, as both a safety net and advocate, is undeniable.

James A. Klotz is the President of FMSbonds, Inc.
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Nov 20, 2014

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