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Quality is Job One

By: Mark Tranckino

Long before there were municipal insurers (of the seven AAA-rated municipal insurers, AMBAC is the oldest, established in 1971), the underlying quality of the municipal bond issuer was paramount. The current financial deterioration of those municipal bond insurers certainly drives home the importance of that point.

It has long been the opinion of conservative municipal market makers that municipal insurance should be treated as “icing on the cake.” In other words, the underlying municipal credit should be able to stand on its own from a quality standpoint.
One look at the insurer’s claims-to-paying ratio would clearly demonstrate that municipal insurance is intended to protect bond holders from isolated default scenarios only. The chart listed below shows that ratio on the seven AAA-rated municipal bond insurers:

Claims-paying Ratio
Ambac Assurance Corp. (AMBAC) 62:1
Financial Guaranty Insurance Co. (FGIC) 98:1
Financial Security Assurance (FSA) 92:1
MBIA Insurance Corp. (MBIA) 82:1
Assured Guaranty (AGC) 45:1
CIFG Guaranty 77:1
XL Capital Assurance (XLCA) 72:1

But paying claims for defaulted municipal bonds has not been the problem. Enter the herd of esoteric corporate IOUs. No, indeed it would appear that the age-old element of greed has been the culprit. Municipal insurers, in an effort to grow their business, began insuring much riskier structured debt. In fact, one of the seven AAA-rated insurers, Assured Guaranty has over half (51.7 percent) of its portfolio of insured bonds composed of structured debt.
Most of these insurance companies are currently trying to take dramatic steps to right their financial ships. On Dec. 12, MBIA announced that it had entered into an agreement whereby Warberg Pincus, a global private equity firm, would inject $1 billion of capital in MBIA through a combination of a stock purchase and a stockholders rights offering. At the time of submission of this article, Fitch and Moody’s Investors Service is in the process of reviewing capital adequacy analysis with the strong possibility of downgrading at least some of the major insurers. This could lead to a situation whereby a bond could have a higher underlying rating than the company that is insuring it. As you read this article, most likely further developments in this situation have occurred and information on the status should be readily available.

In another move, AMBAC Financial Group, the world’s second-largest bond insurer, is passing off the risk of $29 billion of the securities it guarantees. Assured Guaranty LTD will reinsure the debt, allowing AMBAC to free up capital. The assured debt will not include any CDOs, but hopefully frees up enough capital for AMBAC to retain its AAA rating.

The financial maneuvering implemented by these companies doesn’t seem to have fooled the ultimate judge, Wall Street, as is witnessed by the following erosions of their equity prices:

Insurer 52-week High Current Price % Decline
AMBAC 96.10 23.84 75
MBIA 76.02 29.51 61
RAM Holdings  17.34  4.80 72
Security Capital 34.58  3.56 90

So where does that leave the holder of these insured bonds? It leaves them on easy street as long as the entity itself is a viable credit. Ideally, that analysis was done at the time of the purchase and continues to be monitored over the holding period. The beauty of the electronic age is that current financial information is readily available on all but the most obscure of credits. Generally speaking, if you have followed the guidelines of your investment policy, you should be fine. All of this reminds us of an old bond saying that really applies to any purchase, “Quality remains long after the price is forgotten.”

Mark Tranckino is senior vice president of the capital markets group of Country Club Bank in Kansas City. He can be reached at 800-288-5489.

Copyright © January 2008 BankNews Publications