Bond insurance is back.
Bond insurance never really left, of course, even after most of the insurers lost their top ratings at the end of 2008. And even when Assured Guaranty lost its AAA in 2010, the firm continued to underwrite new business.
If anyone had any doubts about the viability of the idea of credit enhancement, Standard & Poor’s sought to answer them in a special report last week, “U.S. Bond Insurers And The Financial Guarantee Sector Stand At A Crossroads,” which accompanied the rating company’s upgrade of both Assured (to AA from AA-) and MBIA’s National Public Finance Guarantee (to AA- from A). Build America Mutual is already at AA.
Bond insurance is “still necessary,” said S&P. And: “We expect business volume for bond insurers to rise through 2015 and for the industry’s risk-adjusted pricing ratios to improve.”
S&P analysts led by David Veno said they expect insured penetration to rise to 7 percent or 8 percent in 2014 (this would be up from about 5 percent so far this year), and that the next two years will be “crucial” for the business.
I read this to mean that the rating company won’t revisit the industry for another two years in any meaningful way, i.e., it won’t come in and downgrade everyone.
This is about as hearty an endorsement of bond insurance as we are likely to see. Rising interest rates and an increase in volume as municipalities rebuild infrastructure should do the rest.
Bond insurance confounds some people. They ask why it should exist at all when issuers hardly ever default? As what we might call the late unpleasantness has shown, well, sometimes they do, and in spectacular ways.
As for issuers, they extract their value from the product on day one in the form of less expensive borrowing costs.
The survival, and reconstruction, of the bond insurers is also good news for anyone who is concerned with the vitality of the professional side of public finance. Simply put, the business is better off, and the issuers are better served, when it has more participants.
The municipal bond industry, the middlemen who advise and underwrite and sell securities for states and localities, is a very small place. With the prosecutions, cutbacks and consolidations of recent years, it has gotten even smaller. Some of the nontraditional buyers who feasted on Puerto Rico two weeks ago are just now finding out how small the market is, and how illiquid munis can be.
This is why S&P’s analysis last week was so important. It was like a little vote of confidence in a market that has been besieged by bad news for years.