The history of the Municipal Bond Insurance Industry dates back to 1971 with the founding of the American Municipal Bond Assurance Corp., (“AMBAC”). The benefits to using municipal bond insurance by issuers or obligors of municipal indebtedness were quite straightforward. The primary benefit is to reduce borrowing costs, as the inclusion of insurance on new issues garnered a AAA rating, and, thus, carried a lower interest rate. In addition, bond insurance helped enhance visibility and liquidity for investors, and guaranteed the timely payment of principal and interest when due, should the obligor default on its payments to investors.
Bond Insurance Penetration
In 1975, New York City’s fiscal crisis put fear in the municipal bond market of a possible payment default, and, as a result, the “safety net” feature of bond insurance helped it gain a greater prominence for issuers and investors alike. Another tailwind to the fledgling bond insurance industry in the earlier years was a more favorable interest rate environment, as rates were higher. This allowed the business to thrive, as the upfront premium paid by the issuers and obligors could better fit in the spread between uninsured and insured bonds, and promote greater savings to the issuer. In contrast, recent years’ low interest rates have hindered the bond insurance industry.
Market Opportunity Attracts Entrants
As the years passed, new entrants came into the market, and eventually each had the prized Aaa/AAA ratings assigned to their respective claims-paying ability. Names like Municipal Bond Insurance of America (MBIA), Financial Guarantee Insurance Corporation (FGIC), Bond Investors Guaranty (BIG), Financial Security Assurance (FSA) –which is now Assured Guaranty Municipal (AGM) – Assured Guaranty Corp. (AGC), and others began appearing on the covers of municipal offering prospectuses for new issues. The holdings of insured paper also increased in the secondary market for institutional investors and the broker/dealer community.
In the earlier days of the insurance market, the Aaa/AAA insurers had their own creditworthiness criteria and tended to write their business to a “no loss” standard. This meant that Aaa/AAA insurers guaranteed only solid investment-grade credits, those with “AA,” “A” or, selectively, “BBB” underlying credit quality. This dynamic left room in the municipal bond market for insurers with less capital and a lower claims-paying ability to insure the credits that the “big boys” did not want in their portfolios. Radian Asset Assurance (AA at the time) and ACA (A at the time) are examples of companies created to fill such a void.
Penetration Sky Rockets
Through the 80s and 90s, bond insurance grew significantly as a percentage of the outstanding debt. The annual ratio of insured paper to debt issued in the municipal bond market is also known as the “penetration rate”. To put the pace of growth in context, in 1980, the annual penetration rate was 3.0%, but by 2007 it was almost 60%! In effect, the market quickly became commoditized with the AAA ratings of the insurers and the resultant prices or interest rates assessed with municipal debt had less regard for the underlying credit and obligor. However, the hey-days were about to come to an abrupt end.
In the mid-90s, some bond insurers strayed into unchartered waters. Instead of insurance for municipal credits only, certain companies started insuring structured financial products that made use of mortgages – called residential mortgage backed securities (RMBS) and other derivatives. The products the insurers were guaranteeing had investment grade underlying ratings by the rating agencies, sometimes as high as “AAA.” Although these products were outside the realm of traditional municipal insurance, many rating agencies and bond insurers enjoyed the large fees that these instruments garnered. In fact, for some, insuring these esoteric structures became a greater portion of their insured book of business than the municipal bonds they insured.
The Bust and Consolidation
Unfortunately, this business took a severe hit in 2008, when the housing market collapsed and certain mortgages and other non-performing assets dragged down the investment instruments that had been created, some of which had been insured. Moody’s and S&P downgraded many of the RMBS transactions they rated – both insured and uninsured – and due to this mortgage and structured product exposure, the prized Aaa/AAA ratings of the insurers were gone.
A secondary effect of this was industry consolidation. The instability in the bond insurance market opened the door for more stable players – such as Assured Guaranty – to make acquisitions and grow the business. Assured Guaranty acquired FSA, and then, more recently two smaller companies named Radian Asset Assurance and CIFG. Other bond insurance firms generally curtailed their new business operations and are in run-off of their existing insured portfolios.
However, despite turmoil in the crisis, the bond insurance industry continues to have a strong place in the markets.
While some investors may view product and geographic diversification as a strength, others may prefer a municipal bond insurer with no structured finance or international exposure. In 2012, Build America Mutual (BAM) launched with a goal to insure only U.S. municipal obligations. Other insurers have also created insurance units that guarantee U.S. municipal debt only. Assured Guaranty launched Municipal Assurance Corp. (MAC) in 2013 as a U.S. muni-only complement to its global public finance platform, AGM, and MBIA created National Public Finance Guarantee Corporation (NPFG) to house its U.S. public finance portfolio apart from its legacy structured and international businesses. NPFG began writing new business in 2014.
As of 2015, bond insurance penetration stood at 6.4% of the municipal bond market. That is up from 5.5% in 2014. The current ratings tell some of the recovery story as well. Although Fitch withdrew all of its insured ratings, in some cases at the request of the insurer, and has not restored, or in some cases been asked to restore them, other ratings show the cross section of health in the market. AMBAC was below investment grade until its ratings were withdrawn and is under Regulatory Supervision as it emerged from bankruptcy in 2013, while companies such as AGM (A2 /AA /AA+), MAC (NR/AA/AA+), BAM (NR/AA/NR) and NPFG (A3/AA-/AA+) are rated appreciably higher. (Ratings are from Moody’s Investors Service/S&P Global Ratings/Kroll Bond Rating Agency). Assured Guaranty (including AGM and MAC) is the clear market share leader in the business today in terms of both par written and premium generated.
Will the municipal bond insurance penetration rate reach 60% again? While one never wants to say never, it seems unlikely. Among other things, so much of that answer depends on variables such as the underlying ratings assigned to issuers and obligors and the ability of insurers to upgrade that rating, the overall interest rate environment and the concomitant cost of capital. Additionally, questions remain as to whether defaults such as Detroit and Puerto Rico will spark investors’ desire for the credit enhancement that municipal bond insurance provides. In the current low interest rate environment, a likely path is for a stable to improving bond insurance market that continues to provide another layer of security and opportunities for reduced volatility and enhanced market liquidity for investors – and reduced borrowing cost for issuers.
About the Authors
This article was written by Bernard Garruppo and Gary Binkiewicz.
Bernard is a Partner and Managing Director of R. Seelaus & Co., Inc., the corporate parent of Granite Springs Asset Management, LLC, where he previously served as Chief Executive Officer. He has almost 30 years of experience in municipal and other fixed income markets.
With over 35 years of municipal bond market experience, Gary has managed and/or created municipal bond research departments at several Wall St. firms as well as having experience in the rating agency, bond insurance and buy-side and sell-side municipal bond credit research spaces. He is a long-standing member of the National Federation of Municipal Analysts (NFMA), and the Municipal Analyst Group of New York (MAGNY).
Learn more about Bernard and Gary here
Sponsored by Assured Guaranty Municipal Corp., Municipal Assurance Corp. and Assured Guaranty Corp., New York, NY. This article is for informational purposes only and does not constitute (a) an offer to sell or a solicitation of an offer to buy any security, insurance product or other product or service, (b) financial, tax, legal, investment or accounting advice, or © advice with respect to any municipal financial products, or the issuance of any municipal securities, including with respect to the structuring, timing or terms of any such financial products or issuances. None of the sponsors or any of their affiliates is acting as an advisor in connection with any municipal financial product or any offering of municipal securities