No tears for bond insurers

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By Dan Jamieson

November 19, 2007 6:01 am ET

Not everyone is worried about the possibility that municipal bond insurers' ratings are at risk.

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This month, Fitch Ratings Ltd. and Moody's Investors Service Inc., both of New York, said that they are reviewing the bond insurers due to guarantors' exposure to collateralized debt obligations.

That news spooked an already-jumpy market and created the concern that some tax-free mutual funds might have to dump downgraded bonds.

A downgrade is seen as unlikely. But the focus on the role of bond insurance was welcomed by critics who say that the widespread practice of insuring bonds has commoditized the market.

Insurers "suck all the yield out of the market," said Matt Fabian, a Westport, Conn.-based senior analyst with Municipal Market Advisors of Concord, Mass. "Investors end up overpaying for their bonds."

About 60% of new municipal offerings this year were insured, according to research from Smith Barney, the brokerage unit of New York-based Citigroup Inc.

But a single-A municipal has more safety than a triple-A corporate, Mr. Fabian said. "Rating agencies have shown that," he said.

"Insurance companies aren't going to insure [a bond] if there's a chance of it not paying," said Greg Ghodsi, a Tampa, Fla.-based broker with Raymond James & Associates Inc. of St. Petersburg, Fla. "So it's been a great business" for insurers, he said.

Insurance is added mostly for marketing purposes, Mr. Fabian said. Insured bonds are easier to sell and don't require a discussion about credit history.

"If people don't think [insurance is] valuable, they can always go with uninsured bonds. Half the market is uninsured," said Peter Poillon, spokesman for Ambac Financial Group, Inc. (ABK).

"We provide tremendous benefit to investors" and other market participants who find municipal-issuer financial statements tough to read, he added.

A spokeswoman for MBIA Insurance Corp. (MBI) of Armonk, N.Y., said the firm had no immediate comment.

Those firms are the two largest bond insurers.

Shares of bond insurers have gotten hammered recently, with most of the damage occurring last month after concerns about subprime exposure hit the news.

Ambac's share price has fallen to about $20, from about $90 in May. MBIA's stock has dropped below $40, from about $70 in May.

In general, however, bond insurers argue that aside from protecting against defaults and the risk of a downgrade, insurance enhances liquidity and simplifies risk assessment for investors who may otherwise be turned off by complicated bond structures.

Mr. Ghodsi said that if investors are willing to embrace more volatility on certain issues, they will be rewarded with extra yield.

"As long as you're holding to maturity, you shouldn't care about market valuation," Mr. Fabian said. "Municipal prices are widely unreliable anyway."

In the meantime, Mr. Ghodsi sees worries about bond insurers as a good thing because it encourages advisers to get back to the basics of doing research on bonds and focusing on underlying credit quality.

A Nov. 9 report from Smith Barney said that recent weakness in the municipal bond market is, in part, due to "a transition from overreliance on the bond insurers to a more 'balanced' environment."

Dan Jamieson can be reached at djamieson@crain.com.