Wednesday, February 13, 2008

Bond insurance: Do muni investors still care?

We know the monoline insurance business has been one of the great flaming disasters of the Great Subprime Collapse of 2007. Unlike some other businesses which have taken big losses, like mortgage lenders or brokerages, its not clear the world really needs bond insurers at all. We know that there will be such a business as home building in 2010, but are we so sure anyone will want bond insurance in 2010?

Let's look at the monoline insurer's bread-and-butter (municipals) for some guidance. According to data from Thomson Financial, only about 28% of municipal bonds issued in January carried insurance from a monoline insurer. That's down from 46% in 2007. Meanwhile, according to Merrill Lynch, new insurance was dominated by FSA and to a lesser extent, Assured Guaranty. FSA insured $3.8 billion of new issues, about 70% of all new issue munis which carried insurance. Assured picked up most of the remainder ($1.3 billion or 23% of new insured issuers).

The argument against insured municipals is pretty simple. Municipal default rates are extremely low, with most issues backed directly or indirectly by state and local governments. Issues backed by operating entities (e.g., private hospitals) are not commonly insured. So why buy insurance against a security that very rarely defaults?

And yet until recently, municipal bond buyers routinely demanded bond insurance. Why? Individual municipal credits are difficult to analyze. Its hard to get up-to-date financial information on some small school district in Indiana. Bond insurance (it was thought) eliminated the need for analyzing specific credits. Instead, the buyer could rely on the insurance policy to cover the small possibility of a default.

This attitude hasn't changed. Muni buyers are the same people they've always been. Put it another way: what percentage of muni fund managers wish the insurer problems would just go away, that we could go back to the old way of doing things?

And maybe we can go back. This morning, Warren Buffett was on CNBC outlining a plan to reinsure $800 billion in municipal bonds currently insured by FGIC, Ambac, and MBIA. In theory that would make the insurance problem (from muni buyer's perspective) just go away. He said that one insurer already turned down his plan, but his proposal remains significant. It means that there is private sector capital ready to get into the municipal insurance business.

The fact is that confidence in insurance has never been lower, and yet buyers continue to demand insurance at all tells you something. MBIA and Ambac may never be able to regain AAA levels of confidence, but municipal bond insurance as a concept will survive.

14 comments:

Anonymous said...

As a former retail muni broker, your best (but always most unsophisticated clients) demanded AAA / insured. These little old widows were told by their late husbands to only buy that way,

My buddy had a great close - "the YTM is 4.70% an its AAA rated AND INSURRRRED - Yup, just like wearing a belt and suspenders at the same time!" I always laughed when he said that.

the cds trader said...

i find it interesting that no-one out there is really talking about potential muni defaults. with a slowing economy and lower tax revenues generally, i'd expect defaults to materially increase. so muni yields seem way too low to me...i wouldn't go near the market until it REALLY reprices...

fyi though, i am no muni expert....

Kicker said...

Insurance makes municipal bonds fungible. Insurance is a necessity if the short term funds muni funds are going to survive.

Barry Garner said...

What muni investors? All the acution rate note auctions are failing. Would they fail if bonds were wrapped by a real AAA counterparty?

Sam Cass said...

There was an article about the muni risk on BestCashCow several months ago. Personally, I'm that concerned about municipal defaults. I can't think of any except Orange county and that was really unrelated to the general economy. Does anyone else have other examples of munis going under?

That being said, the first commentor is correct. People like my mother would never buy a bond that wasn;t insured.

Nick Gogerty said...

Muni bond defaults according to moodys have included 18 issuances since 1968. This is out of roughly 700,000 issuances. Insurance is bogus. I watched the senate testimony yesterday live. Unfortunately the insurance firms do not have enough resource for a 100 year storm. There have been 4 major crises in the countries history. This puts the odds of such a storm at roughly 1 in 80. The default rate according to moody's research would be similar to corporates in teh 1930's, which would wipe out the monolines. The CDO's of course have already effectively done that.

Anonymous said...

Very good post...best I've seen. I've been in munis, insured is demanded on a TECHINICAL basis only. Retail wants it because it is AAA but they dont have the time to understand it is AAA already, Moodys just has it wrong. Insurance companies want AAA because their regulator incentivizes it. Mutual funds want AAA because retail wants it and they can then charge more for non-AAA funds. Hard to justify those fees otherwise. Ask anyone of the actual traders and they will tell you, give me the uninsured all day long.

As for the CDS trader, false hope from Team NY (Dinallo/Spitzer) is stalling it. But keep in mind that Cal had a much larger deficit and outlook (remember brownouts) to the poiint they recalled their governor, and they came out OK. New Orleans/Gulf Coast is still hanging in there.

Accrued Interest said...

Yeah I really don't think municipal bond quality, in general, should be questioned. Even Orange County paid all creditors in full.

Anonymous said...

Who should I get in contact with about a states own laws about mortgage broker bonds and as such, how would I get a mortgage bonds form? I life in England and am considering moving to America, don’t know where yet however I was doing some general reading about housing and came across the term mortgage broker bonds and am a little confused, is it a mortgage or a loan to acquire a mortgage?
Also if I want to set up life insurance do I need insurance bonds? Or can I simply open a policy with a company? Im a little confuse by some of the jargon. I am not moving anytime soon but thought I should be aware of things I will need to understand.

jon said...

Can you tell me what Surety Bonds are? I have heard of Corporate Surety Bonds but I don’t understand what they are, can you help?

Accrued Interest said...

What's the context?

Alexie said...

Bond insurance
Thanks for posting this

Movie News said...

Do all contractors have to have performance bonds in order to work for you? Before I go ahead with a building contractor to make my new driveway (this will be the second time, the first contractor pretty much took my money and ran), I want to make sure everything is above board and would rather not have to spend £100's of pounds having a solicitor look into it. Are surety bonds something that all UK building firms must hold before starting a job, or is it only in America?

Colorado insurance said...

you say argument against insured municipals is simple but i dont get it?

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