Tuesday, November 13, 2007 0 comments ++[ CLICK TO COMMENT ]++

Do we need bond insurers?

Really... do we need bond insurers? That's the question being asked by many, the latest being Joe Mysak at Bloomberg. With the chaos in the bond insurance market, this is a good question to ponder if one is thinking of investing in the bond insurers. After all, one shouldn't invest in something that has no viable business plan and is actually worth zero. Joe Mysak goes on to comment about what has been happening in the bond markets lately.

The municipal market hasn't worried about this situation. I took a look at last week's negotiated and competitive bond sales calendars to see if the current whirlwind surrounding the insurers has made a dent in their ability to win business, at least in the municipal market...

Of the 150 transactions on the negotiated calendar last week, 68 carried insurance. That's more than 45 percent of the number of deals. During the same week last year, 71 of the 149 negotiated deals were insured -- almost 48 percent. A handful of these were school bonds guaranteed by the state of Texas's Permanent School Fund, but still. What's going on here?

Well, for one thing, negotiated deals are usually set up pretty far in advance. The hysteria over the bond insurers only reached fever pitch a couple of weeks ago. In a negotiated transaction, bond issuers choose the underwriter of their bonds, and the underwriter gets to work selling them. On the actual day of sale, the bonds are already entirely sold, in most cases.

The market still seems to be using the bond insurers in the market where bond deals are negotiated ahead of time. The real question mark is the market where investors bid for the bonds:

On the competitive side of the calendar, where issuers set a date and underwriters bid for the bonds at auction, the situation was different. Of the 84 issues on the calendar, only 34 carried insurance -- about 40 percent.

In the negotiated market, the issuer usually pays for bond insurance; at auction, it's the underwriter who usually pays.

And now the clincher: On the competitive calendar for the same period last year, 57 of the 91 transactions were insured -- almost 63 percent.

At auction, then, there seems to be some reluctance to use insurance. This development bears watching.

It looks like the usage of bond insurance has declined. Since this is simply anecdotal evidence, it is questionable how much any of this means. For instance, some of the decline might actually be due to the insurers themselves cutting back. Given that bond insurers are trying to preserve capital, this wouldn't surprise me. Nevertheless, it is worth pondering if the credit crisis will permanently destroy the need for bond insurance. I suspect not but it will be interesting to see what happens if one of the bond insurer gets downgraded.


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