Ross Sees Competition as Sign Insurance Awakening: Muni Credit
After more than two years dominating a shrinking municipal bond-insurance market, Wilbur Ross is looking forward to some competition.
The 74-year-old billionaire, who owns 10.2 percent of Assured Guaranty Ltd. (AGO), says the arrival of Build America Mutual Assurance Co. signals the viability of a business that was left for dead after credit markets collapsed in 2008, devastating the U.S. financial system and ushering in the worst recession since the Great Depression.
Last year, 5.2 percent of the $290 billion of muni debt sold in the U.S. was insured, all by Assured, data compiled by Bloomberg show. The protection, which localities use to lower borrowing costs, once covered half the bonds offered by U.S. states and local governments.
“Being a one-horse industry was a very hard thing,” Ross said in an interview last month at Bloomberg’s New York headquarters. “Two sales forces out there promoting the industry is a very good thing.”
Those sales staffs face a challenge in persuading municipalities that were burned by bond insurance why they need the product when they’ve grown accustomed to borrowing without it. The job has been made tougher by the Federal Reserve’s policy of keeping its benchmark interest rate near zero through at least mid-2015. Municipalities are borrowing at the lowest rates in a generation even without insurance.
Yields on 10-year general-obligation bonds rated BBB, the second-lowest investment grade from Standard & Poor’s, set a record low of 3.01 percent this month, data compiled by Bloomberg show. The bonds’ extra yield over AAAs fell to 1.1 percentage points on Aug. 28, the smallest since 2008.
Lower-rated issuers can reduce their interest costs through insurance, which gives their borrowing the same credit rating as the insurer. The muni insurance arm of Assured is rated AA- by S&P and Aa3 by Moody’s Investors Service, the fourth-highest grades from both.
Protection from Assured Guaranty Municipal Corp., which is based in New York, saves issuers 0.10 percentage point to 0.25 percentage point in interest cost compared with uninsured bonds, according to an August report from William Clark, a Hartford, Connecticut-based analyst at Keefe, Bruyette & Woods Inc. The average premium issuers paid in 2011 was 0.65 percentage point of total debt service, up from 0.37 point in 2006, according to KBW.
“One of the critical components of our contract, which is saving you financing costs, has been kind of taken away by how the Fed has been managing monetary policy,” Assured Guaranty Chief Executive Officer Dominic Frederico said at a conference sponsored by KBW last month.
Assured guarantees a combined $1 billion of Jefferson County, Stockton and Harrisburg bonds, with 70 percent of the total coming from Jefferson County, according to KBW. Assured estimates losses in the Alabama county at $50 million. The insurer has $313 million in reserves related to its public- finance risks and $13 billion in claims-paying resources, according to KBW.
About $6.3 billion of the nearly $450 billion of public- finance obligations Assured has insured is rated below investment grade, according to KBW.
During the financial crisis, companies including MBIA Inc. (MBI) and Ambac Assurance Corp. were stripped of their top credit ratings because of losses on guarantees of subprime-mortgage- backed debt. Municipalities that had bond insurance from the companies saw interest rates on their floating-rate debt skyrocket. Investors holding insured securities suffered as prices fell.
Assured managed to survive, in part as it mostly avoided the losses that felled its competitors. Assured’s stock has returned about 12.3 percent this year, including dividends, while the Russell 1000 Financial Services index has earned 25.6 percent.
“What happened to the insurance companies scared the bejesus out of everybody,” said Matt Dalton, who oversees $1.2 billion of munis as chief executive officer of Belle Haven Investments Inc. in White Plains, New York.
“Adding competition in this interest-rate environment with an investor base that has lost belief in insurance for the most part isn’t good,” he said.
Build America Mutual, or BAM, based in New York, insured its first deal last month, a $10 million sale by Pennsylvania’s York Suburban School District. It became the first new company to guarantee munis since Warren Buffett’s Berkshire Hathaway Assurance Corp. entered the market in 2007. Berkshire has stopped writing policies.
BAM, which has $500 million in claims-paying resources, is rated AA by S&P, one level above Assured.
“Within a calendar year of our opening, if we insured 3 percent of the market we could consider that successful,” BAM Chairman Robert Cochran said on Oct. 11 at a conference in Chicago. “We’ll see where market demand takes us.”
S&P estimated in a July 23 report that BAM may insure $12 billion of bonds in its first year.
While BAM may take market share from Assured, its entrance into the business could restore legitimacy to bond insurance and help expand the industry, said Clark at KBW.
“Having 100 percent of market share of a market that keeps shrinking is probably not the best thing in the world,” Clark said in a telephone interview. He has a 12-month price target of $16, compared with $14.47 at 4:15 p.m. New York time yesterday.
Analysts such as David Veno at S&P in New York predict that insured bonds may eventually rebound to account for more new issuance. There are enough smaller, infrequent borrowers to support Assured and BAM and restore insurance to as much as 30 percent of sales, he wrote in a July 23 report.
The different underwriting strategies of Assured and Build America “support the notion that total insured new-issue paper may increase,” he wrote.
As a mutual insurer, issuers who buy policies, not stockholders, will own BAM. The company will focus on general- obligation debt and so-called essential service bonds backed by specific revenue sources such as tolls.
BAM’s mutual structure allows its cash to grow as each new policyholder contributes, reducing the need for external capital.
However, as a startup, BAM may lose money initially and have less appeal to issuers and investors because it’s not an established player, Clark wrote in an August report when he started covering Assured’s stock.
On the downside for Assured, Moody’s has its financial strength rating on negative watch because it views new business opportunities as limited.
Clark, who predicts Moody’s will lower Assured’s rating, said a reduction won’t affect its business.
“People who are still using bond insurance now are going to be OK with a AA- stable rating from S&P, which is only one level below BAM’s rating and isn’t a significant disadvantage,” he said.
In the $3.7 trillion muni market yesterday, benchmark 10- year tax-exempts yielded 1.66 percent, compared with about 1.82 percent for similar-maturity Treasuries, data compiled by Bloomberg show.
Treasuries prices fell following a jump in new-home construction. That left the interest rate on 10-year local debt at about 91 percent of the federal yield, the lowest since February. Investors look at the ratio to gauge relative value between the two asset classes. The lower it is, the more expensive munis are compared with Treasuries.
Following is a pending sale:
CALIFORNIA plans to sell about $550 million in general- obligation refunding bonds as soon as Oct. 23, according to the state treasurer’s website. The debt will be sold via auction. (Added Oct. 15)
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