History of Bond Insurance
Issuers that meet certain credit criteria can purchase municipal bond insurance policies from private companies. The insurance guarantees the payment of principal and interest on a bond issue if the issuer defaults. Bond ratings are based on the credit of the insurer rather than the underlying credit of the issuer. A municipal bond insurance policy is intended to result in significant interest cost savings, depending upon the issuer's underlying credit and market conditions at the time of the bond sale. Interest cost savings are attributable to the higher bond rating as well as enhanced liquidity for insured bonds.
Triple-A municipal bond insurance emerged in 1971. From 1971 to 2007 the number of insured issues grew astronomically. In 1980, only 3% of bond issues were insured compared to approximately 60% in 2007. In 2008, there was an estimated $2.5 trillion of municipal bonds of which more than half were insured. With growing popularity of insurance, the number of insurers also increased. AMBAC, the first insurer, was latter joined by other triple-A rated insures. In addition, insurance companies with claims paying ability lower than triple-A entered the market to provide opportunities for insuring bond issues that were too small, unusual or had credit conditions that did not meet AAA insurers' criteria.
In addition to insuring municipal bonds, many of the Municipal Bond Insurers insured collateralized debt obligations. Beginning in 2007 insurers' credit ratings came under review due to subprime mortgage exposure. This exposure threatened the insurers claims paying ability and resulted in rating downgrades. In 2007, there were seven insurers rated triple-A by the three major rating agencies. Today none of the insurers are triple-A rated.
In 2009 Assured Guaranty Corp. and Financial Security Assurance had the highest
ratings of the bond insurers. On July 1, 2009, Assured Guaranty Corp completed an
acquisition of Financial Security Assurance. (See ratings below.)
How Bond Insurance Is Acquired
Historically, bond insurance is purchased through a one time payment of a premium at the time of the bond closing. (Depending on the issue BAM may have both upfront and annual premiums.) Not all issues qualify for insurance. Each insurer has its own credit criteria, although the categories reviewed are essentially the same as those used by the rating agencies (see Bond Ratings). The process of insuring a new issue begins with the issuer submitting documentation for review (such as the official statement, financial statements and bond documents). If the issue qualifies for insurance, the policy may be purchased by "direct purchase" or "elective bidding". In a direct purchase, the issuer purchases the insurance policy directly from an insurer. Elective bidding allows bidders to choose whether or not to insure an issue at the time the bonds are competitively sold. In an elective bid, each bond dealer submitting a bid assesses whether the acquisition of insurance will result in a better bid. If the winning bidder submits a bid with insurance, the bidder pays for the insurance policy.
Who Are The Bond Insurers
The following table sets forth the websites for the bond insurers that were triple-A rated in 2007 and their current bond ratings:
In addition to the foregoing insurers is Berkshire Hathaway
Assurance. Formed in 2008, the company has
The ratings noted in the above table reflect the claims paying ability of the bond insurer. Insured bonds do not automatically receive these ratings. Generally, insurers do not recommend or require ratings from any particular rating agency. The issuer must determine which, if any, ratings it will purchase for the insured bonds. The issuer is also responsible for paying the rating fee to each rating agency that assigns ratings to the bond issue. While a bond issue may be insured by only one rating agency, if the insurer's rating is reduced by any rating agency, the market value of the bonds could be affected.
In a direct purchase, the issuer determines the feasibility of acquiring insurance. This requires an analysis of the projected interest cost differential for uninsured bonds compared to insured bonds. The interest cost savings should be more than sufficient to offset the cost of the insurance premium. Furthermore, since the premium is paid at the time of the bond closing and interest cost savings (if any) are realized over the term of the bonds, a present value analysis is the preferred approach for determining whether insurance results in cost savings.
Role of WM Financial Strategies
For your municipal bond issue, WM Financial Strategies will explore the feasibility of obtaining a municipal bond insurance policy. WM Financial Strategies begins with an analysis of your credit condition, the issue structure and current market trends. If, the acquisition of insurance appears to be feasible, WM Financial Strategies applies for a municipal bond insurance policy from one or more of the insurers listed above that maintains a high credit rating. If the issue qualifies for insurance, a recommendation whether to buy insurance is made based on the analysis described above (see "Assessing Feasibility").
Rating Actions and the Great Recession
Since 2007, Moody's Investors Service, Standard & Poor's and Fitch have been reviewing bond insurers to determine their subprime exposure and whether their capital remains adequate to maintain their present ratings. Due to the loss of demand for bond insurance, insurers that do not have subprime exposure have also come under review. The table below is a summary of credit rating actions relating to insurers that were AAA rated prior to December 2007. (For a more detailed description of actions taken since October 2007 see Bond Insurance and the Great Recession).
Visit the Association of Financial Guaranty Insurers for additional information relating to municipal bond insurance.
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