"Muni Bond Insurance Buffett Called Dangerous Delivers Comeback
By Joe Mysak
May 8 (Bloomberg) -- Municipal bond insurance is showing signs of renewal this year as new providers respond to demand from low-rated borrowers whose costs have increased three times as fast as for issuers with top credit grades.
Leading guarantee firms, including Ambac Financial Group Inc. and MBIA Inc. forfeited top credit ratings last year after losses related to subprime mortgage-backed securities. The amount of insured new issues plunged 64 percent in 2008 as the biggest bond-insurance firms wrote down at least $21.3 billion, according to data compiled by Bloomberg.
An early contender to replace them, Warren Buffett’s Berkshire Hathaway Assurance Corp., was downgraded to Aa1 by Moody’s Investors Service in April. The billionaire investor in February called tax-exempt bond guarantees “a dangerous business.” His firm insured $3.3 billion in issues last year, ranking third in the industry.
Buffett’s warning isn’t stopping Macquarie Group Ltd., Australia’s biggest securities firm, from backing a new guarantor: Municipal and Infrastructure Assurance Corp. plans to sell its first policy by July, said Richard E. Kolman, the New York-based startup’s executive vice chairman.
“It is surprising to find that municipal bond insurance is anything but moribund in the early going in 2009,” wrote Philip J. Fischer, a Merrill Lynch & Co. municipal strategist in New York, in an April 6 report.
Carrie Gray, a spokeswoman for Merrill Lynch, declined to make Fischer available for comment.
Municipal and Infrastructure Assurance will join new subsidiaries of Ambac and MBIA, along with industry leader Assured Guaranty Corp., in trying to revive so-called credit enhancements. In all, insurers covered $72 billion, or 18 percent, of new tax-exempt bonds last year. That was down from $201 billion, or 47 percent, in 2007.
The amount of insured issues may rebound to about 35 percent over the next two years, said Guy Lebas, chief economist at Janney Montgomery Scott LLC in Philadelphia. Most of that work may go to a nonprofit firm that issuers hope to create, he said.
“I’d like some more diversity in names” to avoid having the same company backing too many issues, said John F. Flahive, who manages $22 billion in municipal debt at BNY Mellon Wealth Management in Boston.
Almost 70 percent of the firm’s tax-exempt bond holdings are insured, he said.
The coverage guarantees payments on bonds that defaulted about one-fifth as frequently as AAA corporate debt from 1970 to 2006, according to a Moody’s study in 2007. The policies equalize investors’ risk of lending to issuers of varying quality. In exchange for an upfront premium, borrowers use the firms’ credit ratings instead of their own.
Issuers rated BBB, Standard & Poor’s Corp.’s next-to-lowest investment grade, currently pay 4.75 percent to borrow for 10 years, according to Bloomberg data. The rate for insured general obligation bonds is 3.4 percent -- a difference of $135,000 on each $1 million of debt over the life of the loan.
The gap between yields on BBB- and AAA-rated issuers is about 152 basis points, Bloomberg data show. While down from a record 357 basis points in March, it remains “historically wide,” said Kolman, 54, who spent 25 years in municipal bonds at New York-based Goldman Sachs Group Inc., before retiring in 2007. A basis point is 0.01 percentage point.
Between January 2000 and January 2007, the mean spread was 52.9 basis points.
In 2006, when at least seven companies competed, premiums were as low as 15 basis points, according to a December report by the National League of Cities and the National Association of Counties. That meant issuers borrowing $1 million for 10 years paid as little as $2,212.50.
With competition dwindling, insuring A-rated general obligation bonds may now cost from 30 basis points to 75 basis points Kolman said -- or as much as $11,062.50 on $1 million for 10 years.
Starting in the mid-1990s, the top companies expanded into guaranteeing mortgage- and asset-backed securities. That business soured in 2007 as subprime mortgages began defaulting at record rates. As guarantors reported losses, their shares plunged.
The market value of four municipal-bond insurance firms -- Ambac, MBIA, Assured Guaranty and Syncora Holdings Ltd. -- declined to about $2.7 billion from a high of $45.6 billion in May 2007.
Borrowers with variable-rate debt saw interest rates rise as guarantors lost top ratings. Jefferson County, Alabama, had converted $3.2 billion in sewer debt to auction and floating- rate. Two of the county’s five commissioners suggested declaring bankruptcy in March, partly because downgrades allowed banks to demand the county buy back almost $1 billion in debt.
This year, Assured Guaranty, rated Aa2 by Moody’s and AAA by S&P, covered an industry-leading 426 municipal bonds with a par value of $9.3 billion in the first quarter, according to an April 3 statement.
Its closest rival, Financial Security Assurance Inc. of New York, wrote 122 policies, totaling $1.2 billion. Assured Guaranty, backed by billionaire Wilbur Ross, agreed in November to buy FSA for $722 million in cash and stock.
Municipal and Infrastructure Assurance, which is also backed by Chicago-based hedge fund manager Citadel Investment Group LLC, will be capitalized at $500 million, Kolman said. It will have the advantage of no subprime baggage, he said.
“Unlike the legacy insurers, the ones who built the business since its establishment in 1971, nobody is going to wonder about the next shoe to drop,” he said.
MIAC deserves a rating of AAA because “our strategy is not to diverge away from municipals,” said Tim Bishop, president of Macquarie Capital (USA) Inc. in New York.
Macquarie, an early proponent of privatizing public facilities, has acquired interests in four toll roads in Chicago, Indiana, California and Virginia.
The new subsidiaries of Ambac and MBIA say they also deserve top ratings.
Ambac’s rankings were cut to Ba3 -- 12 grades below the top tier -- by Moody’s on April 13. Its municipal bond subsidiary, called Everspan, will merit the “best available ratings,” said Douglas Renfield-Miller, the firm’s chief executive officer. That may be AA, he said.
Seeking Top Ratings
Ambac, whose shares have fallen 99 percent since October 2007, intends to raise $1 billion in capital, and Everspan would begin selling coverage sometime in the second quarter, Renfield- Miller said.
National Public Finance Guarantee Corp., MBIA’s subsidiary, is in talks with raters, said Thomas McLoughlin, CEO of the unit.
Third Avenue Management LLC, a New York mutual fund manager, sued the parent company last month to try to block the spinoff. The complaint in Delaware Chancery Court says the move would harm debt holders. MBIA has declined 93 percent since October 2007.
Two hedge funds, Aurelius Capital Management and Fir Tree Partners, filed a similar suit in federal court in New York in March. McLoughlin declined to comment on the litigation.
Competition would inevitably force new insurers to cut prices and take on other types of risk, Moody’s said in November.
“A municipal-only guarantor’s ability to overcome these circumstances is likely to be quite challenging,” the rating company said.
Moody’s assigned a negative outlook to U.S. local governments as a whole for the first time on April 7. It cited “unprecedented fiscal challenges” to counties, cities and school districts arising from the steepest recession since World War II.
Buffett, whose Omaha, Nebraska-based Berkshire Hathaway Assurance guaranteed $241 million in the first quarter, said on May 3 that the firm is selling fewer policies lately.
“We basically don’t like the pricing,” he said during a gathering of reporters after a press conference in Omaha. “If you have the wrong pricing, you can lose a lot of money.”
Moody’s downgraded the parent company, Berkshire Hathaway Inc., last month, citing “the severe decline in equity markets over the past year as well as the protracted economic recession.” It also cut financial-strength ratings for the company’s insurance units.
Buffett told investors in February that governments with guaranteed debt might choose to default rather than raise taxes. “Insuring tax-exempts, therefore, has the look today of a dangerous business -- one with similarities to the insuring of natural catastrophes,” he wrote.
“What mayor or city council is going to choose pain to local citizens in the form of major tax increases over pain to a faraway bond insurer?” he asked in his annual letter to shareholders.
“With all due respect to Mr. Buffett, I’m sure a lot of issuers are pretty insulted by that,” Kolman said.
New municipal bond guarantors are needed -- though perhaps not as for-profit businesses, said Lebas of Janney Montgomery Scott.
Public Insurer Planned
“I would actually anticipate some form of nonprofit solution to come down the pike in the long run -- something akin to a municipal bond bank or issuers’ association,” Lebas said in an e-mail.
Such an entity could cover as much as 25 percent of new issues over time, while traditional companies handled about 5 to 10 percent, he said.
In December, the National League of Cities and National Association of Counties endorsed creating a “voluntary, national mutual credit-enhancement company owned and operated by local governments.”
They’re putting together a business plan for the nonprofit entity and plan to ask the U.S. Treasury for $1 billion in capital, said Cathy Spain, director of the league’s Center for Member Programs in Washington. Andrew Williams, a Treasury spokesman, said the agency had no comment.
Representative Barney Frank of Massachusetts, the Democratic chairman of the House Financial Services Committee, said in February that the federal government should get into the business.
Issuers Slam Ratings
Demand for bond insurance would disappear if states, cities and counties received fair credit grades, according to a third group of public-finance officials, led by California Treasurer Bill Lockyer.
Tax-exempt issuers should be rated as corporate borrowers are, on their chance of default, the officials say. Doing so would result in upgrades for many municipalities.
The issuers sought federal legislation to speed rating changes. Local leaders have asked that the Municipal Bond Fairness Act be reintroduced in Congress after failing to pass in 2008.
Meanwhile, some issuers are going without credit enhancement and paying more to borrow. On April 13, the Butler Health System, a nonprofit hospital and physician group about 35 miles north of Pittsburgh, sold about $76 million in revenue bonds to help pay for an expansion.
‘Lot of Demand’
“We looked at Assured Guaranty, and talked to them, but didn’t pursue it because we didn’t think the pricing would be in our best interest, given the turmoil in the market,” said Andy Majka of Skokie, Illinois-based Kaufman Hall & Associates, the Butler, Pennsylvania medical group’s financial adviser.
Assured doesn’t comment on issues it hasn’t backed, said Ashweeta Durani, a spokesman for the firm.
Butler Health sold its bonds with a Baa1 rating from Moody’s and A- from Fitch, and paid yields that included 7.4 percent on $47.5 million due in 2039 -- about 217 basis points over the Municipal Market Advisors Consensus scale.
“We’d welcome the formation of new insurers -- there’s a lot of demand for credit enhancement,” Majka said.